In the same article quoted in yesterday's blog (March 2010 Journal of Financial Planning by Bodie, Fullmer and Treussard), the author's stated other traps and fallacies:
"...the false notion that stocks are an effective hedge against inflation, the fallacy of time diversification of risk, and reliance on probability statistics as a measure of risk..."
It is true that in the high-inflation periods of the 1970's and early 1980's stocks did perform poorly, but overall, with mild inflation (less than 4%), the effects are not correlated. The authors state that "...empirical studies show that stock returns are largely uncorrelated with inflation..."
Bodie (1995) shows that "...the cost of this insurance [to insure that an investment will, at least, earn the risk-free rate] increases with the time horizon...and can be replicated by purchasing a put option...prices...in fact increase with the length of the time horizon..."
Though the chances of experiencing declines in a portfolio increase over time, the average ending result still may be higher than just taking a non-stock approach. Never any guarantees either way.
To continue, "...probability theory has strongly influenced...economics...from its 17th century founders, Blaise Pascal and Pierre de Fermat...Pascal...reasoned that knowing the probability of an event was not enough. The consequences of the event matter, too. Thus, risk has two dimensions. One involves the probabilities of certain events. The other involves the consequences of those events..."
The consequences could be not reaching your retirement goal because of being too conservative or too aggressive. Again, either method could be true.
An Introduction
Hi. Welcome to BourGroup and my blog. Phil
Phil Bour is a CERTIFIED FINANCIAL PLANNER(tm) professional since 2004, a Magna Cum Laude college graduate and an accounting professional for over 35+ years. I love numbers, statistics and economic history.
I am also an Enrolled Agent (EA) to represent taxpayers before the Internal Revenue Service and to prepare tax returns.
"Phil"osophy: I believe that you can manage your money on your own (not necessarily through individual stock selection but through mutual funds, ETF's and other solutions) once you receive some one-time, professional guidance. Why pay annual fees when there may be little added value? For additional information, first read the "An Introduction" label at the left. Then move on to others.
Phil Bour is a CERTIFIED FINANCIAL PLANNER(tm) professional since 2004, a Magna Cum Laude college graduate and an accounting professional for over 35+ years. I love numbers, statistics and economic history.
I am also an Enrolled Agent (EA) to represent taxpayers before the Internal Revenue Service and to prepare tax returns.
"Phil"osophy: I believe that you can manage your money on your own (not necessarily through individual stock selection but through mutual funds, ETF's and other solutions) once you receive some one-time, professional guidance. Why pay annual fees when there may be little added value? For additional information, first read the "An Introduction" label at the left. Then move on to others.