Excerpted from Bogle on Mutual Funds by John C. Bogle, pages 29-32

The most widely accepted measure of the risk in any financial asset class is the volatility of its total returns. Volatility risk, quite simply, refers to the fact that a diversified portfolio will fluctuate in value and may show a loss during any interim period. However, if a diversified portfolio that is held for, say, five years achieves a satisfactory increase in value (even though it may have decreased in value during the interim), it may be said in retrospect that the investment was, for all practical purposes, safe. The distinction, then, between a safe investment program and a volatile investment program lies in the time horizon of the investor.

As shown in Figure 2-2, volatility is extremely high for common stocks when measured over one-year holding periods. Over the past 67 years, the annual total return earned by common stocks has varied from a high of +54% (1933) to a low of -43% (1931), a spread of fully 97 percentage points. There were 20 years in which common stock total returns were negative and another nine years in which their total returns fell below the long-term average of +10.3% for the full period.

As you can see in Figure 2-3, increasing the length of the period during which stocks are held tends to reduce the volatility risk reflected in Figure 2-2. While the spread in annual returns is 97 percentage points, over full decades the average annual return spread drops to 21 percentage points (a high of +20% in 1948-58 and a low of -1% in 1928-38). Over 25-year periods, the average annual total return spread falls to just nine percentage points (+15% in 1942-67 and +6% in 1928-53). It is a critical tenet that the volatility risk in common stocks is reduced as the holding period increases.


If you can afford the luxury of reinvesting dividends and you have a truly long-term time horizon, the total return risk of common stocks is quite tolerable. Not only does the magnitude of the disparity in returns diminish as the holding period lengthens, but the possibility of achieving a negative return decreases as well. What is more, if you also add new capital to your stock holdings regularly (or even spasmodically), in good times and bad alike, total return risk should be negligible.

It seems only logical that making many investments in the stock market at periodic intervals - known as dollar-cost averaging - will provide greater stability of return than a single all-at-once commitment. The reason is that a large single investment determines, for once and for all, the price at which you have committed your assets. By investing the same number of dollars at regular intervals over time, regardless of the market's prevailing price level, you buy more shares when stock prices are low and fewer shares when stock prices are high, virtually assuring a satisfactory average purchase price of your holding. In addition, the regular reinvestment of dividends, year after year, irrespective of the level of stock prices, contributes still further to the effectiveness of dollar-cost averaging.

The value of dollar-cost averaging emerges clearly from a study of past returns on stocks. Table 2-4 contrasts the best ten-year period for the stock market with the worst and illustrates how the range of returns may narrow using a program of yearly investments rather than a single lump-sum investment.

Clearly, the magic of compounding, combined with the normalizing effect of dollar-cost averaging, minimizes the volatility of investment returns. What is more, making regular annual investments of $1,000 each year rather than an all-at-once commitment would have reduced your effective average annual total return by less than one percentage point during the best decade. But it would have increased your effective average return by nearly eight percentage points during the worst decade. As far as investing in common stocks is concerned, dollar-cost averaging suggests that slow-and-steady will likely win the race.