From John Norstad’s at now defunct norstad.org: Portfolio theory teaches that we can decrease the uncertainty of a portfolio without sacrificing expected return by diversifying over a wide range of assets and asset classes.
Some people think this principle can also be used in the time dimension. They argue that if you invest for a long enough time, good and bad returns tend to “cancel each other out”, and hence time diversifies a portfolio in much the same way that investing in multiple assets and asset classes does.
For example, one often hears advice like: “At your young age, you have enough time to recover from any dips in the market, so you can safely ignore bonds and go with an all stock retirement portfolio.”
This kind of statement makes the implicit assumption that given enough time good returns will cancel out any possible bad returns. This is nothing more than a popular version of the supposed “principle ” of time diversification. It is usually accepted without question as an obvious fact, made true simply because it is repeated so often, a kind of mean reversion with a vengeance.
While the basic argument that the standard deviations of the annualised returns decrease as the time horizon increases is true, it is also misleading … uncertainty increases with time.
Common variants of this time diversification argument can be found in many popular books and articles on investing, including those by highly respected professionals and even academics.
But, the fact that some highly respected, justly admired and otherwise totally worthy professionals use this argument does not make it correct.
Unfortunately it’s difficult to dismiss because it is so ubiquitous that it has become an unquestioned assumption in the investment world.
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