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.

A (Very) Brief Digression on Economic History

I normally wouldn't want to venture into this territory, but there are certain facts which have been distorted somewhat due to the fact that this is a political season and somewhat due to the fact that some people want to push certain narratives. I just wanted to provide some simple facts that I think have gotten distorted.

One is that the 1970s were an absolutely hellish decade while the 1980s were wall to wall prosperity. This is true when it comes to the performance of financial markets where stocks had a wretched decade in the 1970s, largely due to the fact that they entered the decade with elevated valuations due to the run ups in the 1950s and 1960s, but also because interest rates rose throughout the decade due to inflation from the Federal Reserve's incompetent management of monetary policy (and due to certain oil producing countries behaving badly).

However, in terms of income growth it certainly wasn't horrible. Here are the CAGR numbers for inflation adjusted personal income by decade.

1950s: 4.06%
1960s: 4.62%
1970s: 3.50%
1980s: 3.13%
1990s: 3.07%
2000s: 2.48%

The same holds reasonably close with GDP, which shouldn't be a surprise since income growth and GDP should be closely related.

Part of the reason the stock market was so nicely positioned for a good decade in the 1980s was that nominal earnings had risen substantially during the 1970s while nominal stock prices remained practically constant, even down somewhat. As a result, stocks in the first few years of the 1980s were badly undervalued. The PE ratio of stocks in April of 1980 was about 7x trailing earnings. Once interest rates began to fall to more reasonable levels, stocks appeared badly undervalued.

If there's a lesson from this it is probably that you should always look up data yourself rather than believe it wholesale from someone who is trying to make an ideological point or create some kind of narrative of the financial markets.