Investment Returns Are Non-Random

Money Bizwiz Team
0 Min Read

When it comes to investment time horizon and portfolio allocations, there is ongoing debate among academics. The research released by the CFA Institute Research Foundation delves into this topic in depth.

What we discovered challenges the assumption that returns are independent over time, both within domestic and international markets across different asset classes like stocks, bonds, and alternatives.

These findings suggest a need for investment professionals to reconsider their portfolio optimization methods, such as mean variance optimization (MVO), which typically operate under the assumption of random returns over time.

This blog post is the first in a series of three. Here, we provide background on how returns have historically evolved over time. In subsequent articles, we will discuss the implications for equity portfolios and portfolios containing real assets like commodities.

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Risk and Investment Horizon

One commonly held belief is that the risk of asset classes like equities decreases over longer investment periods, often referred to as “time diversification.” But evidence suggests that this view may not hold true, as shown in Exhibit 1 based on US equity returns from 1872 to 2023.

Exhibit 1. The Distribution of Compounded Equity Returns by Investment Horizon 1872 to 2023.


However, focusing on compounded wealth rather than compounded returns tells a different story, as seen in Exhibit 2. This divergence challenges the notion of time diversification.

Exhibit 2. The Distribution of Compounded Wealth by Investment Horizon for an Equity Investor 1872 to 2023.


Our research findings challenge the belief that returns are random over time and reveal the presence of autocorrelation. To explore this further, read our paper, “Investment Horizon, Serial Correlation, and Better (Retirement) Portfolios.”

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