How Long Is the “Long-Run”

Investing for the “long run” is sage advice.  We’ve heard it a million times.   The problem with that advice is ambiguity.  How long is the “long-run”? 

This article will provide analytic evidence of just how long the “long-run” is for various asset classes as well as a four-asset portfolio.  (I would have built and tested a broadly diversified portfolio with more than four asset classes but historical performance data back to 1926 are only available for four primary asset classes).

This analysis examines the performance of large cap US stock, small cap US stock, US bonds, and US cash over the 98-year period from January 1, 1926 to December 31, 2023. 

The specific indexes representing each asset class are as follows:  large cap US stock is represented by the S&P 500 Index, small cap US stock is represented by the Ibbotson Small Stock Index from 1926-1978 and the Russell 2000 Index from 1979-2023, US bonds are represented by the Ibbotson US Intermediate Government Bond Index from 1926-1975 and the Bloomberg Aggregate Bond Index from 1976-2023, and US cash is represented by 90-day Treasury Bills.

First question:  does the past 98 years represent a long-run time frame?  I propose that it is—at least it’s the longest time frame we can practically measure.  Thus, for the purposes of this analysis, the 98-year period from 1926-2023 qualifies as a benchmark measurement of long-run performance.  With that proposed, this paper examines investment periods shorter than 98 years and how the performance in the shorter time periods compares to the 98-year benchmark performance. 

Long-Run Performance

Shown below in Table 1 are the average annualized returns for each asset class and a 4-asset portfolio over the past 98 years.  The 4-asset portfolio had a 60% stock/40% fixed income “balanced” allocation consisting of 40% large cap stock, 20% small cap stock, 30% bonds, and 10% cash.  The 4-asset portfolio was rebalanced annually.

Over the past 98 years, large cap US stock produced a 10.28% average annualized return, small cap US stock generated an 11.02% annualized return, US bonds were at 5.03% and US cash returned 3.24%.  The 4-asset portfolio produced a 98-year average annualized return of 8.91%.

Not surprisingly, the 98-year standard deviation of annual returns (a common measure of volatility) is dramatically smaller for US bonds and US cash compared to US large stock and US small stock.  It is worth noting that a diversified 4-asset portfolio achieved a “long-run” return of nearly 9%, but with 31% less risk than 100% large cap US stock. 

Let’s get to the real question:  how long do we need to invest in a particular asset class (or portfolio of asset classes) to achieve--or come close to--the “long-run” return?   Recall, we have established the 98-year return as representative of the coveted “long-run” return that investors are seeking.

As shown in Table 2, if you invested solely in large cap US stock you achieved a return equal to or higher than the long-run return of 10.28%% in 84% of the rolling 35-year periods (and there were 64 rolling 35-year periods).  If you only stayed invested in large cap US stock for 30 years, you achieved a return equal to or higher than 10.28% in 68% of the rolling 30-year periods.  A 25-year holding period achieved or bettered the “long-run” return 50% of the time. 

If investing in a 60/40 portfolio (comparable to the one specified here) a holding period of at least 35 years produced a return equal to or greater than 8.91% (the 98-year “long-run” return) 84% of the time.  If only investing for 15 years the long-run return was achieved in only 56% of the 84 rolling 15-year periods.

The analysis in Table 2 illustrates that the term “long-run” is clearly more than 20 years.  In fact, it’s not until we invest for at least 35 years that we see success rates above 80%--if “success” is defined as equaling or beating the long-term return of that particular asset class or portfolio. 

Another key observation is that none of the individual asset classes, nor the 4-asset portfolio, achieved a success rate of higher than 57% if investing for only 5 years.  This signals that a 5-year investing period clearly does not qualify as “long-run”.

We now need to augment the information in Table 2 with additional analysis shown below in Table 3.  We have observed that large cap stock produced a long-run return of 10.28% or higher 84% of the time over rolling 35-year periods.  This means that it failed to do so in 16% of the 35-year rolling periods.  The question is:  how big was the performance deficit when the long-run return was not achieved?

In other words, how much below the long-run return of 10.28% was US large cap stock during those 35-year periods in which it failed to achieve the long-run return?  Answer:  the average performance deficit was 52 bps.  Said differently, over extended time frames (in this case 35 years) investing in a 100% large cap US stock portfolio produced a long-run return (of at least 10.28%) 84% of the time—and when it failed to do so the 35-year return was within 52 bps of 10.28%. 

The plot thickens as the time frame shortens.  If only investing for 10 years, a 100% large cap US stock investment delivered the long-run return of 10.28% only 49% of the time (as shown in Table 2).  That means it under-performed the long-run return 51% of the time—and the average amount of underperformance was 430 basis points--a sizeable performance gap. 

When the 4-asset portfolio failed to achieve the long-run return of 8.91% over rolling 35-year periods it only missed by 56 basis points on average.  Over rolling 5-year periods, it missed by 466 bps when it failed to achieve the long-run return.

Clearly, the longer the investment period the closer we will be to the sought-after long-run return.  And if we come up short, we’ll be closer to the long-run return if our investment period is longer.

Summary

This analysis has clarified that the “long-run” is at least 30-35 years for equity-based asset classes and equity-dominant portfolios.  More specifically, when investing in a diversified equity and fixed income portfolio for at least 35 years there is an 84% probability of achieving the “long-run” return.

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