What is the expected time frame?

The most important factor in determining our exposure to growth assets is the expected investment time frame. Growth assets over time have higher returns, but are also more volatile. The aim of financial planning is to select the appropriate level of growth assets to suit an investor’s needs.

The longer the time frame, the safer it is to have a higher exposure to growth assets.  In finance statistics the reason for this is known as Mean Reversion. This essentially means that despite having unstable results in the short term, over long periods of time the average is reasonably stable and predictable.  Over any given year, the range of results is quite large, with returns either well above or well below long time averages.

Over an extended period, we are going to experience a number of good and bad years. The more years we have, the more likely it is we are going to have a total return closer to the long term average.

As mentioned above, the higher exposure to growth assets, the greater variety in investment returns.  This translates to a greater number of results (of both good and bad years) required for an accurate return to be predicted.

In practice, this means we need to invest for an appropriate length of time so that we have enough good and bad years.  That way, the average return will be somewhere near what we expect (i.e the long term average).

More conservative investments have a much lower range of returns; meaning we don’t have to invest for as long.

If we invest in a portfolio with a high exposure to growth for a short time period, and the markets experience a loss in the first or second year, it is conceivable that we will lose money on the investment, or at least experience returns below what we would expect.

For a portfolio consisting solely of growth assets, it is recommended to invest for a period of at least 9 years.  Alternatively, a portfolio invested in 50% growth assets would have a minimum time frame of about 4 years.

For these reasons, when developing an investment portfolio, the first thing we look at is how long we are prepared to lock up the money. This dictates how aggressive we can be with a portfolio – conservatively for the short term and higher growth options for goals in the more distant future.