Popular wisdom says, “Time in the market reduces your risk.” Is this true? In short, yes, but only if you hold the right assets. In this article, let’s further explore the relationship between Risk vs. Time.
Risk vs. Time Correlation for Different Asset Classes
Let’s look into three asset classes for illustration:
Cash
In the short term, holding cash poses almost no risks. However, if you keep it for a long time, you will likely lose its value due to inflation. The longer you hold the cash, the higher the risk of losing its purchasing power.
You can observe this correlation in your daily life. For example, a bowl of noodles cost $5 last year, but today, thanks to inflation, it costs $6. The same $100 cash bought you 20 bowls of noodles last year but only 16 bowls this year. Imagine how much that bowl of noodles will cost you in ten years. That same $100 may only buy you ten bowls. The longer you hold that $100 cash, the higher the chances that its purchasing power will be eroded by inflation. Ouch!
Bonds
Holding bonds in the short term exposes you to relatively minor risks. However, the longer you keep them, the higher the risks from possible default and inflation. For example, a 6-month bond will expose you to a much lower risk than a 10-year bond. The chances of a default are smaller within six months compared to ten years. Additionally, not all bonds can beat inflation; therefore, holding them longer exposes you to higher chances of purchasing power erosion.
Stocks
Stocks are volatile. You may lose money years after you buy stocks, even the good-quality ones. In the short term, stock prices may fluctuate based on market sentiments. However, if you hold them for the long term, the possibility of a positive return increases every day. Please note that this applies only to fundamentally strong businesses. A business with solid fundamentals can raise its prices to keep pace with inflation and remain profitable. This kind of stock will allow you to beat inflation over the long term.
What Can We Learn?
Risk can positively or negatively correlate with time, depending on the asset class.
Our illustrations above show that risk positively correlates with time for cash and bonds, meaning the longer you hold them, the higher the risks. On the other hand, risk negatively correlates with time for stocks because as you hold the stocks longer, the chances for positive returns are higher.
As investors, we need to understand our investment objective and time horizon. Investing in the short term is different from investing in the long term.
If you invest for the short term, asset classes such as cash and bonds offer relatively lower risks, while asset classes such as stocks pose higher risks.
On the other hand, if you are investing for the long term, cash and bonds may pose higher risks due to purchasing power erosion, while stocks may pose relatively lower risks.
