Time diversification revisited by William R Reichenstein

By William R Reichenstein

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The 25-year-old grandson should hold the same portfolio as his 70-year-old grandmother. Twenty years later, Samuelson (1989) presented three cases with different implicit or explicit assumptions. Each case justified younger people investing more of their portfolios in risky assets than older people. The first two cases apply regardless of whether the random walk or the mean-reversion model is used. In the first case, suppose Mary, a portfolio manager, believes Bob, her client, should increase the risk level of his portfolio.

For the S&P 500-perhaps the most widely accepted market benchmark-at least 15 years are needed to reach 90 percent confidence that stocks will beat cash and at least 25 years to reach 95 percent confidence. For a stock-only portfolio, the long run can be very long indeed. Table 13. 5 Note: See Table 1for asset allocation details. The results are more encouraging for the diversified age portfolios. For example,for the ten-year holding period for the mean-reversionmodel inTable 13, shortfall risk is estimated at less than 10 percent on all of the age portfolios.

The benefits of time diversification are minimal for these holding periods. Investments for retirement and some other goals, however, typically have much longer horizons. Most retirement funds have an investment horizon of 20 years or more. A 55-year-old worker may plan to retire in 10 years but has a life expectancy of 20 to 30 years. Most workers do not plan to cash in their assets at retirement, so why should they set their investment horizons at their retirement dates? If the 55 year old expects to live until 85 and to withdraw funds evenly between the ages of 65 and 85, then he or she has an average investment horizon of 20 years.

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