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How long is a long-term investment?

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  • Pu Shen
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    Abstract

    Conventional wisdom tells us that stocks tend to outperform government bonds in the long term. That is, if stocks are held long enough, they are usually better investments because their total return is likely to be higher than the return on bonds. While this view may be correct in principle, in practice a crucial question remains: How long is long enough? The answer is important to every investor, not just the wealthy few. With employers relying increasingly on defined-contribution retirement plans, employees must make their own saving and investment decisions. ; Shen reviews historical patterns to show investors how the riskiness of stocks and bonds can change as an investor’s holding period lengthens. First, she explains why stocks are generally considered riskier than government bonds and thus, on average, should pay higher rates of return to attract investors. She then shows why stocks, with their higher average rates of return, tend to perform better over sufficiently long holding periods. Next, she examines the historical patterns of stock and bond returns in the United States. She shows that sufficiently long has been very long relative to most people’s holding periods. Finally, she examines various holding periods in detail. She finds that, for many investors whose holding periods were not sufficiently long, risks for both stocks and bonds were quite high. She concludes that, historically, longer holding periods may have reduced the riskiness of stock investments but not bond investments. Further, for most individual investors, feasible holding periods have seldom been long enough to take full advantage of long-term stock investments.

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    File URL: http://www.kansascityfed.org/Publicat/econrev/Pdf/1Q05shen.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

    Volume (Year): (2005)
    Issue (Month): Q I ()
    Pages: 5-32

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    Handle: RePEc:fip:fedker:y:2005:i:qi:p:5-32:n:v.90no.1

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    Related research

    Keywords: Investments ; Bonds ; Stocks;

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    Cited by:
    1. Christophe, Faugere, 2003. "A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination," MPRA Paper 15579, University Library of Munich, Germany, revised 04 Jun 2009.

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