I went to see Interstellar last night. I won’t ruin it for you, but if you’re in to things like time travel, intergalactic travel and space ships then you should probably go see it. One of the central themes of the movie is relative time discrepancy. Due to gravitational anomalies time in the movie is a relative unknown.
Naturally, this got me thinking about how this relates to money and investing. Money, after all, is essentially a way of trading our time so we can obtain access to other needs and wants within the economy. Investing in financial assets is a way of trading money now to obtain more money in the future. Money and time aren’t just related. They are two sides of the same coin.
Therefore, time is a key element in our investing lives. But it’s also a relative unknown. In my book I call this the “intertemporal conundrum” – the problem of time in a portfolio. That is, we have our own relative time discrepancies in our financial lives. The majority of academic models that discuss investing use a linear model of the financial world and apply financial asset allocations based on this linear thinking. This is the essence of the rationale for “buy and hold” investing. That is, in a linear system with a long enough time horizon stocks will have a more predictable and linear output. That is intuitively obvious and factually true. Of course, this model of the world assumes that it applies to our portfolios in a practical sense when, in reality, it doesn’t since our financial lives are actually a series of events and not the start and stop model that many use for planning. Interestingly, day traders do the opposite. They try to trade their way to the future thereby playing a game of low probabilities and high frictions generally resulting in financial ruin.
So what’s the problem here? Well, our lives aren’t these clean linear experiences. Our lives are a dynamic series of events (graduations, marriages, children, emergencies, retirement, elderly care, etc). And since our savings portfolios are comprised of the repositories from which we decipher our ability to make choices about future spending then this repository can’t be all that dynamic. It has to be somewhat stable. The logic behind this is very simple. If our investing timelines exist on a relatively short period (maybe 30-40 years?) and our earnings and spending needs are dynamic over that period then why would we apply a model of the world that implies that we can actually hold certain asset classes for the entirety of that time period? More importantly, it begs the question whether anyone actually WANTS to hold that asset for the entirety of this investing period. As Keynes said, in the long-run we are all dead and I don’t know about you, but I don’t work all day hoping to die with a casket full of unspent money.
This becomes even more evident when we apply realistic examples. For instance, most of us do not have a “long-term” time horizon to begin with. This is due to the fact that most adults do not amass a significant savings until they are in their 40’s or 50’s. If you have a retirement goal of 65 then your investing time horizon is actually not so “long-term”. More importantly, as you get older your portfolio will likely require adjustment to reduce your risk exposure. This means that a 30 year old who is 100% invested in stocks does not actually own a “long-term” portfolio if they adjust their portfolio to a 50-50 stock bond portfolio when they are 50. It means that 50% of their portfolio was actually invested in a “stocks for the 20 year period” portfolio. In addition to life’s necessary expenditures which disrupt our savings there is no practical application of the academic idea of a linear “long-term” model. It simply does not apply to real-life in the way that some academic models assume. As Daniel Kahneman once said “the long-term is not where life is lived”.
And this is the danger of the ideas espoused by advocates of “the long-term” or the “short-term”. These models try to distort time and often apply approaches that result in a highly impractical approach to portfolio management. There has to be something in the middle. Something more balanced that accounts for the dynamism of the financial system and our financial lives. Anything else is impractical and defies the reality of the way our portfolios relate to our actual financial time frames.
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