The third concept affecting risk and return is time frame. Time frame is the amount of
time an investment is expected to be held. Purchase of high
volatility assets would be nothing more than gambling if one were
planning to invest for a few months or a few weeks. Likewise, buying
lots of shares of a single stock for a short period of time is very
risky. It has been shown that one would actually do better picking
stocks throwing darts at the financial pages than by trying to select
them when the period is a year or less. This is true even if
professional money managers are doing the picking.
Because stocks are volatile, it is difficult to predict price over short periods of
time, between one and three years. Remember that the prices for
shares presented by the market are not necessarily rational at any
given time. Stocks that are overpriced can continue to rise. Those
that are dirt cheap can get cheaper. Even if one buys shares in a
great company, the general market sentiment can cause the price to
fall and stay down for short periods of time. There is also
manipulation, various trading strategies, and all kinds of random
events that can affect prices over the short-term. Maybe you’ll buy
that great stock and then the founder will decide to unload a bunch
of shares and buy a house.
It is much easier to predict stock prices over long periods of time because the price will
eventually follow the fundamentals. In addition, stocks have a
natural tendency to rise as the economy grows and earnings increase.
Returns on stocks over long periods of time have averaged between ten
and fifteen percent — much better rates that most other
Also, buy buying shares regularly, rather than putting all of one’s money in at once, one
can also lessen the effects of market fluctuations since more shares
will be bought while prices are low than when they are high. This
process, called “dollar cost averaging,” is a popular and
So the allocation of assets into bank accounts, bonds, stocks, real estate, and other
investments is highly dependant on time frame. For those with only a
few years to invest, the money should be safe in a bank CD despite
the terrible interest rates. For those who are saving for retirement
and have decades to let the money grow, the money must be in assets
with more return than the bank or inflation will decrease the actual
value of the account each year. Ironically, many in 401K accounts invest only in bank CDs, not wanting to take the risk of investing in stocks. Over a lifetime, this will make the difference between an account with a few hundred thousand dollars and millions.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.