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Why Stocks Are a Risky Long-Term Investment

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The longer we stay in the market, the more likely we are to experience a disaster.

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Earlier this fall, the SEC accused a well-known personal finance expert, Ray Lucia, of misleading investors and ordered him to stop making false claims.

My reaction to this was twofold: (1) I'm glad my column is obscure enough that the SEC has no interest in me, and (2) this guy was advertising surefire investment gains based on a common fallacy promoted by lots of other smart people who should know better.

Maybe you believe in it, too. But you shouldn't and here's why:

The fallacy is that investing in the stock market is less risky over long periods than short periods. It's not. It's riskier.

This is not just my opinion; it's a mathematical fact well known to academic finance experts and options traders, supported by historical evidence, and largely ignored by the public and financial advisors alike.

There's a Hole in the Bucket

Ray Lucia's investment strategy, used by his advisory practice and promoted on his radio show and in a series of bestselling books, is called Buckets of Money. It's mostly aimed at people at or near retirement.

The concept is that you separate your retirement savings into three buckets for short-term, medium-term, and long-term (15+ years) spending needs.

The short-term bucket is invested in low-risk assets like short-term bonds, CDs, and savings accounts; the long-term bucket gets risky stuff like stocks and real estate.

(The medium-term bucket gets somewhat risky or more illiquid assets, like longer-term bonds and fixed annuities.)

The idea is that you withdraw your spending money from the first bucket and periodically replenish the first bucket from the second and the second bucket from the third.

If the market tanks, you can wait it out until it recovers, because you have bucket three hermetically sealed off from the rest of your money, and everyone knows the stock market always does well over long periods, like 15 years.

Now, to be clear, the SEC didn't have any problem with the strategy itself; they accused Lucia of overstating how well it would have performed historically. But this "buckets" idea, which is also promoted by lots of people other than Lucia, is fatally flawed.

It's flawed because there's no guarantee the investments in the third bucket will perform well over 15 years or any period of time, no matter how long.

Moshe Milevsky, author of Are You a Stock or a Bond?, analyzed the bucket strategy in 2006, long before the SEC became interested in Lucia.

"If you are unlucky enough to earn a poor sequence of initial returns," he wrote, "'bucketing' your retirement income is not a guaranteed bailout."

"Great," you may be saying. "I won't put my money in buckets. Sounds complicated, anyway."

Sorry, but if you combine all your assets into the same bucket, you're probably still making the same mistake.

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