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Wednesday, May 7, 2014

How long do you have to hold stocks to smoothe out all of the swings?

This is a question, or some variant thereof, I get quite a lot. We very often hear that you'll earn anywhere between 7-10% on stocks per year over the long term. This is true, but just how long are we talking here? If we do the stretch of 1928-2013, the historical compounded annual growth rate (CAGR) was around 9.2%.

The problem is that after an 85-year holding period you'll look something like this:

5 years isn't anywhere near enough and neither is 10 years. The answer is that you'll have to hold for 20 years or more to really guarantee that you'll get something in that range. Even the 20 year holding periods can swing a little bit above or below those long-term targets, but once you get out to 30 year or 40 year periods we're finally there. You get nice stable rates of return that don't vary much at all. Over those periods, stocks are basically as risky as going to the bathroom. See the chart below. The way to read this is that each line represents the annualized return of that holding period through that year. So, for 1968, the 40-year line represents the annualized return for the 40 years through 1968.

So, if you're thinking 10 years gets the job done and averages everything out, think again. You have to invest with a long time horizon if you want to truly wash out the wild swings.

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