The Risk of Stocks in the Long Run

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April 5, 2012
Capital Ideas

Summary

Lubos Pastor, professor of Finance at the University of Chicago Booth School of Business, discusses how contrary to conventional wisdom, stocks are riskier in the long run.

Investors are often told that stocks are highly risky for anyone investing for a period of five years or less. Extend that to 15 years or more, and they are told the risk of owning stocks falls dramatically because a longer investment period allows more time for a bull market to cancel out a bear market. This conventional wisdom has become the cornerstone of long-term investing and is supported by the historical performance of stocks.

However, according to a recent study by Pastor and Robert F. Stambaugh of the University of Pennsylvania, investors should pay attention not only to historical estimates, but also to the uncertainty associated with those estimates. This uncertainty compounds over time, so that its effect on the volatility of stocks increases, and the volatility over long periods of time can be so high that it can overturn the conventional view.

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