Understanding Time Horizon

Understanding Time Horizon

The first half of the article made the case why benchmarking against the Dow 30 is a bad idea for several reasons which is well and good but in terms of true benchmarking, no one benchmarks to the Dow 30. People might compare to the Dow, the Dow was 10% and I was up 9% or I was up 11% or whatever but they don't benchmark to it.

Later in the article he offered the following bullet points of what investors should be focused on;

  • Capital preservation
  • A rate of return sufficient to keep pace with inflation
  • Expectations based on realistic objectives (the market does not compound at 8%, 6% or 4%)
  • Higher rates of return require an exponential increase in the underlying risk profile. This tends to not work out well
  • You can replace lost capital--but you cannot replace lost time. Time is a precious commodity you cannot afford to waste
  • Portfolios are time frame specific. If you have five years to retirement but build a portfolio with a 20 year time horizon (taking on more risk) the results will likely be disastrous 

These are good talking points although I don't agree with all of them.

Capital preservation is a big one because people seem to always forget how important it is when things are going well in the markets but then wish they'd paid more attention to this when the good times end. It takes a lot of self awareness to avoid complacency and not succumb to greed by meaningfully increase risk after a huge rally.

Exceeding inflation by a point or two may or may not be achievable but it is not an insanely heroic assumption. There will be decades like the 1980's and 1990's again and when that happens your returns will likely be well ahead of inflation. The next time there is a decade like the 2000's your returns will likely be below the rate of inflation. Most of this is beyond our control which is the crux of the argument for taking a long term approach and being disciplined to a strategy that has a reasonable basis for working long term.

The market not compounding at 8%, 6% or 4% is kind of an odd one. The market compounds at some rate over the time period you care about. Depending on how you cherry pick the dates I have no doubt you can find reasonably long periods where the market compounded at all three of those rates. The compounded rate of return for the period you care most about, like maybe age 40 to age 75, will be whatever it will be and be beyond your control. You might get lucky but if you don't want to leave it entirely to chance you could figure out how to increase your savings rate.

I disagree with his framing of the time horizon issue. Clearly having the correct time horizon for your assets is crucial but retiring in five years, to use his example, isn't quite as important as you might think. If you are in your 60's, healthy and your parents are alive (this describes my oldest brother) then chances are good you will be around for a while.

Someone who is right around where they need to be versus their financial plan is going to need growth in their portfolio after they retire. The building block rule of thumb for inflation is that our costs will increase by 50% in 15 years at 3% annualized inflation. From there you can plug in your own particulars.

A 68 year old who is healthy with longevity genes who has retired today and figured out how to live a $3000 monthly lifestyle in today's dollars will very likely be 83, healthy and needing to pay for a $4500 monthly lifestyle. I am not saying to take on more risk or more volatility--proper asset allocation is another crucial component to financial plan success-- but your true time horizon doesn't change from your last day of work to your first day of retirement.

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