August 10, 2010
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Zvi Bodie is Professor of Finance and Economics at Boston University School of Management and has served on the finance faculty at the Harvard Business School and MIT's Sloan School of Management. Professor Bodie has published widely on pension finance and investment strategy. His textbook, Investments, is used in the certification programs of the Financial Planning Association and the Society of Actuaries. His latest book is Worry Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals.
Dan Richards interviewed Bodie at the CFA Institute annual conference in May.
A video of this interview appears here.
I want to talk today about your argument that stocks in the long run are riskier than many people believe. Where does that opinion come from?
What's interesting to me is, how did people ever get the idea that stocks were less risky? You figure the longer you are out there the higher the chance you're going to deviate from the right path. Think about it in terms of hurricanes. You are trying to predict where a hurricane is going to hit the coast. How big is the area of uncertainty when it is far away?
If you go further out in time, you are getting further away from you're starting point. Things that would seem only remotely possible in the short term -- and of course I'm talking about bad things as well as good things -- become probable. People talk about this in terms of the lower tail of a distribution. Books have been written about this, especially lately, because these highly improbable events in the stock market have happened with greater frequency than they should.
So your thesis is quite plausible. The further you go out the greater the uncertainty you experience.
This is really important -- even though the probability of a loss, of an extreme loss is low, it's actually higher in the long run. Extreme losses have a greater chance of happening the further out you go.
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