Note from Our CIO: How Long Is Long-Term?

The only textbook that I’m requiring my students to read this spring for the course I’m teaching at UCLA (“The Science and Art of Investing”) is Zvi Bodie’s little gem Worry-Free Investing. The framework that Bodie provides for matching your goals with your investments is the most important point of the book. Ironically, I disagree with Bodie on the investment instruments that best match long-term goals.

Bodie believes that goals as far out as even 20 or 30 years, including the goal of covering a retirement lifestyle, should be covered only by investing in U.S. government-backed bonds because one should not bet one’s future on the uncertainties of the stock market.

Academically speaking, Bodie’s viewpoint is a nifty way of looking at things: One should view one’s financial goals like a personal pension plan. And just like big pension plans, those goals (like pension liabilities) should be “hedged,” or matched, with high-quality bonds. Essentially, there is no time horizon long enough to justify the use of stocks when it comes to matching goals that must be met. Or so the reasoning goes.

There is one small problem with this view of our personal financial lives as pension plans: Our goals are not fixed or predetermined. For one thing, our long-term retirement goals are inflation-linked. Well, yes, there are inflation-linked bonds (Treasury inflation-protected securities, or TIPS), but our goals will vary even beyond the rising cost of living; they will vary with the rising quality of living and the unpredictability of what our world will look like in 25 years due to innovations that we cannot even imagine today. We’d be blind to history to ignore the high likelihood of those innovations unfolding. The companies that create our better quality of living, as well as the companies that are their vendors and the companies that are their customers, will prosper. Therefore, the safest way (but certainly not a perfect way) to match the goal of keeping up with the rising quality of living is to own equity in these companies.

While the Investment Committee at Abacus certainly agrees with Zvi Bodie that cash flow needs over the next five to seven years should be covered by bonds, we believe that growth assets (stocks and real estate) can be relied upon for matching goals that will be funded more than seven to ten years out. As the chart below shows, the average recovery time from the top of the market before a bear market to the bottom and then up to new highs has been a total of 3.3 years over the past 28 bear markets since 1926. The chart also shows that several notable crashes, including the dot-com bubble and 2008 financial crisis, took longer than average to recover, but were still well within the seven-to-ten-year time frame that Abacus uses for matching goals with stocks.

In today’s era of multi-decade retirements, inflation and the rising quality of living are the retiree’s biggest risks. Unless you’ve saved about 50 times your annual spending, you will benefit from and need growth assets.