How Investment Risk Evolves with Horizon
27 Pages Posted: 19 Oct 2018
Date Written: September 26, 2018
This paper investigates how the nature of risk changes as investment horizon lengthens, and what it means for investors. Accumulated wealth is analyzed in terms of four drivers: expected return, cash flow innovations, discount rate innovations, and reinvestment rates. This perspective highlights how investors with short horizons are justified in primarily focusing on the drivers of price fluctuations, which include changes in both discount rates and market expectations for future cash flows. In contrast, long-term investors should pay particular attention to the initial long-term expected return being offered by the market, whether expected cash flows will be actually realized, and reinvestment opportunities. How the relative riskiness of equities, bonds and cash may vary with horizon is also discussed, including highlighting why fixed income may not be a low risk asset class over longer horizons.
Keywords: investment horizon, investment risk, investment process
JEL Classification: G11, G23
Suggested Citation: Suggested Citation