Research Affiliates: Time Diversification Redux

September 11, 2017

Key Points

  • Conventional risk measures may not accurately describe the volatility investors actually experience, especially for portfolios servicing their retirement spending needs. 
  • Return volatility rises as its calculated holding period nears 1 year and falls as it lengthens to 10 years.  Lower volatility at longer holding periods implies that longer-term mean reversion exists.
  • A portfolio achieves the greatest extra-return benefit by rebalancing over the holding period of highest volatility.
  • Time diversification is helpful, up until long-term uncertainty about the value of reinvested cash flows from dividends leads to rising volatility.


'Tis all men’s office to speak patience
To those that wring under the load of sorrow,
But no man’s virtue nor sufficiency
To be so moral when he shall endure
The like himself. 

—William Shakespeare, Much Ado About Nothing (1598–99), Act V, scene 1, line 27


Investing is traditionally billed as a trade-off between the return and risk of a portfolio. The definition of return—the portfolio wealth gained or lost—is relatively straightforward. But the multitude of quantitative risk measures available to investors today can make the definition of investment risk mysterious and complex. 

A conventional way of defining an investment’s absolute risk is its volatility, or standard deviation of returns. Industry standard practice is to calculate this metric using short-term holding period returns. Monthly—and increasingly daily—horizons are being used by the dominant global investment data analytics providers, such as Bloomberg, Morningstar, and eVestment Alliance. 

But does this conventional, seemingly simple risk measure, calculated using very short-term data periods, accurately describe the volatility investors experience, many of whom have much longer horizons, such as for retirement planning, over which they bear risk? 

We find that the length of holding period we use to assess risk has profound implications for the true level of volatility that investors face in their portfolios. Our analysis also suggests the optimal horizon for rebalancing a portfolio and for determining the period over which we can more accurately predict returns. Before blindly accepting a stated proxy of risk, we owe it to ourselves to understand how risk, as defined by the standard deviation of returns, differs over various time horizons—and importantly, why it matters. 


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