Long-term Investing between Narrative and Reality

This article proposes a critical review of the principles that guide long-term investing, correcting certain common errors and offering a framework for a more accurate definition of the portfolio construction process.

The most common error is associated with the idea of time diversification, according to which a long-term investment reduces and mitigates short-term risks and leads to returns very close to so-called expected returns. The article shows in what sense one may claim that a long-term investment can mitigate short-term risks, and in what sense one must instead acknowledge that long-term investments remain far riskier than is commonly assumed.

Using a range of historical data, we analyze in detail several standard statistics, especially the commonly cited average annualized returns, and highlight some important general characteristics of the behavior of risky assets over long historical periods.

The results preserve the value proposition of long-term investing, but they also show the importance of selecting the appropriate assets and the need to manage risk continuously: the simple Buy-and-Hold recipe is no longer an appropriate strategy in today’s markets (and in truth, it never was).

And if portfolios can be “lazy,” advisors and managers cannot be.