Stocks, Bonds, And The Investment Horizon: Decision-making For The Long Run

The investment horizon is a crucial factor in determining the best investment diversification, as life expectancy exceeds 80 years in many countries. This book analyzes the effect of the investment horizon on the optimal diversification between stocks and bonds, and shows that all relevant parameters for investment choice change in a non-linear way with the horizon. It is recommended to employ the Mean-Variance rule for long-horizon investors and the Sharpe, Treynor, and Jensen performance indices for short-horizon investors.

Format: Hardback
Length: 496 pages
Publication date: 31 May 2022
Publisher: World Scientific Publishing Co Pte Ltd

A century ago, life expectancy was approximately 40 years, allowing individuals to consume all their income without the need for retirement savings. However, today's landscape has undergone a significant transformation. Life expectancy has surpassed 80 years in many countries, leading to a prolonged period of life after retirement. This shift has given rise to a diverse range of investors with varying investment horizons, where the length of the investment horizon becomes a pivotal factor in determining the most effective investment diversification.

In this book, we delve into the impact of investment horizons on optimal diversification, particularly between stocks and bonds. We examine whether young investors and older investors should have the same portfolio, whether savers should adjust their asset allocation between stocks and bonds as they age, and whether the idiom "stocks for the long run" is supported by scientific evidence.

Through comprehensive analysis, we demonstrate that the recommended investment horizon for the Mean-Variance rule varies depending on the specific horizon. We also identify situations where employing this rule can result in economic distortion and a loss to investors. We further explore how all relevant parameters for investment choice, including means, variances, and correlations, change non-linearly with the investment horizon, underscoring the critical importance of considering the investment horizon in investment decisions.

Moreover, we examine the variations in popular performance indices such as Sharpe, Treynor, and Jensen with different assumed horizons, even when considering independence over time. By employing the Mean-Variance rule, Stochastic Dominance rules, and direct expected utility calculations, we provide a comprehensive framework for analyzing these complex issues.

In conclusion, the investment horizon plays a pivotal role in determining the optimal diversification strategy, and its significance extends beyond individual investors. It impacts the performance of investment portfolios and requires a nuanced understanding of the changing dynamics of investment choices over time. By considering the investment horizon, investors can make informed decisions that align with their financial goals and risk tolerance, ensuring a more secure and prosperous retirement.

ISBN-13: 9789811250149