NBK Wealth Thought Leadership: Time Horizon and Asset Risk: Does investment Time Horizon Change the Riskiness of an Asset?

Introduction

When investors consider risk, they usually think of volatility, which is the short-term price movement of an asset. Cash, with its stable nominal value and liquidity, appears safest, while equities seem riskiest due to their daily swings and the visibility of market crashes.

This logic holds until time horizon and inflation are introduced. What feels safe in the short run can be harmful in the long run, while what feels risky can become the most reliable preserver of wealth.

The main problem with cash is inflation. With U.S. inflation averaging 2.5% annually over the past 20 years, purchasing power would fall by about 40% over that period. Investors holding cash or short-term Treasuries, which yielded only about 1.7% on average, effectively earned negative real returns resulting in a slow, almost invisible erosion of wealth.

Equities, by contrast, show the opposite pattern. Short-term volatility is undeniable; the S&P 500 fell about 57% between October 2007 and March 2009. Yet over long horizons, U.S. equities have consistently delivered positive real returns.

Defining Risk

Risk is commonly defined as volatility, measured by the standard deviation of returns. For most investors, however, the real risk is not short-term fluctuation but the failure to meet long-term financial goals. An investor saving for retirement should worry less about daily market moves and more about whether the portfolio’s purchasing power will be preserved 15 or 20 years ahead.

Evaluating risk without reference to time horizon is incomplete and misleading.

·       Time horizon therefore plays a critical role:

·       Short term (0–3 years): focus on liquidity and capital preservation.

·       Medium term (3–10 years): balance growth and stability.

·       Long term (10+ years): prioritize compounding and inflation protection.

Cash and Bonds

Cash is the quintessential short-term asset: fixed in nominal value, instantly liquid, and widely accepted. Yet its apparent safety hides a major weakness: Inflation erosion.

Bonds offer partial protection through fixed income streams. Long-term U.S. government bonds have delivered about 2% real returns over the past century, but they too suffer when inflation rises unexpectedly. The 1970s are a reminder of how bondholders endured negative real returns for years.

Cash and bonds remain essential for short-term liquidity and moderate-term stability, but their safety fades when measured against long-term real wealth preservation.

Chart 1: Cumulative inflation and purchasing power of $100 over the past 20 years

Source: NBKW

Equities

Equities are widely seen as risky because of price volatility and past crises. Yet history tells a different story. Empirical evidence shows that U.S. equities have produced real returns of 6–7% per year over long time horizons, far exceeding bonds and cash. Moreover, volatility declines sharply with time: while one-year equity returns can be negative about 25% of the time, over ten years that likelihood drops below 10%.

Compounding is the mechanism behind this resilience. Reinvested dividends and earnings growth enable equities to keep pace with, and often exceed, inflation. Market downturns are painful but temporary. The investor who bought at the 2007 peak saw a 50% decline by 2009, full recovery by 2013, and more than double the value by 2019. A cash holder over the same period simply lost purchasing power.

Chart 2. S&P 500 Index Long term performance

Source: NBKW

Practical implications for investors

These insights carry significant implications for portfolio construction and financial advice.

·       Investors must align their asset allocation with their true time horizon. For short-term needs, such as a down-payment in two years, cash and short-term fixed income instruments remain appropriate. But for long-term goals, such as retirement funding, equities should dominate because they are an asset with a strong track record of preserving and growing purchasing power.

·       Investor education must emphasize the distinction between volatility and risk. The question of “How much volatility can you tolerate?” could be better reframed as “What is the probability you will meet your future spending needs?” This shift directs attention to the real danger of failing to preserve wealth over time.

·       Tools like target-date funds already operationalize this principle by allocating significantly to equities early in an investor’s life and gradually shifting to bonds as retirement approaches.

·       Equities are being used here merely as an illustrative example to emphasize the effect of time horizon on asset risk. Efficient future-proof portfolios should be well diversified across asset classes and constructed with the specific needs and special circumstances of investors in mind.

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