The Taxable Investor's Manifesto

CHAPTER FIVELengthen Time Horizon to Lower Risk and Enhance Returns

Stocks are less risky than you think. In Chapter 4, we explored the wealth creation potential of a taxable equity portfolio relative to bonds and cash. To me, that alone is a compelling reason to be an equity-oriented investor, even though it's widely viewed that stocks are much riskier than bonds or cash. This perception is based on an investment industry standard measure of risk called the “annual standard deviation of return”; by that standard measure the perception is true – stocks appear much riskier.¹ Measured by annual standard deviation of real return you can see in the left-hand column grouping of Figure 5.1 that stocks have been more than twice as risky as bonds and three times as risky as T-bills.² As you watch the value of your stock portfolio rise and fall day to day, or in any given month or year, your intuition or gut confirms the precise math.

But here is the important kicker: Math is always precise, but the logic behind it isn't always right. Although convenient and widely touted, the one-year time horizon used to measure statistical risk is probably not the right measure for investors who invest for 10, 20, 30 years, or more. The best measure of investment risk is one that approximates your investment time horizon. Look at the last two columns of Figure 5.1 to see what happened to the relative risk of owning stocks, bonds, and cash when longer time horizons are applied to the measure of standard ...