Time Diversification and Horizon-Based Asset Allocations

Abstract

Time diversification, the concept that investments in stocks are less risky over longer periods than shorter ones, has been the subject of spirited debate for decades. Over the last few years the growing acceptance of life cycle investment products, such as target retirement mutual funds, has renewed interest in this topic. The objective of this article is not to prove or disprove time diversification, but to evaluate whether the concept must be valid for a horizon-based asset allocation framework to be viable and appropriate. Our findings suggest that there is little evidence to support the notion that time moderates the perceived volatility inherent in risky assets. However, we would expect the risk/reward relationships of the past to prevail in the future, and if that is the case, a longer investment horizon may support a willingness and ability to assume the greater uncertainty of equity-centric asset allocations. This may be true particularly for younger investors for whom the allocation to human capital and the risk posed by the erosion of purchasing power by inflation can reasonably be assumed to be greatest.