By now every investor knows that stocks are the best long term investment and they typically return somewhere around 10% over the long term. This common knowledge is based on some excellent, well publicized academic studies. Such studies typically look at periods of 70-100 years, sometimes more. These studies give investors a useful framework on which they can base their expectations of the future. They are a good starting point.

However, investors often conclude from this information that if they are long term investors they should expect 10% returns. Any market volatility will be neutralized in the long run and therefore they should always remain fully invested to be sure they achieve this 10% return. Stock investing is often seen as nearly the equivalent of a savings account that pays a 10% interest rate (although the bear market threatens to change this perception).

Is a 70 year study directly applicable to an individual investor? Most people don't have enough money to invest until they are at least in their 30's or 40's. How many of these folks expect to live another 70 years? A foundation or endowment may have a 70 year lifespan but individuals require a different definition of long term.

Due to the current bear market, it is becoming more widely known that popular stock indexes occasionally suffer extended periods of poor returns. While the studies are correct that stocks have done very well over 70 years, there are many historical periods of 5, 10, or 15 years where stock returns have been unremarkable, and sometimes downright poor. If the market can experience such long periods of poor stock returns it may not be appropriate to always be fully invested in stocks. It seems a risky strategy to completely ignore the short and intermediate term.

Yet, ignoring the short and intermediate term is exactly what investors are doing when they say things like 'the market will come back' or 'stocks always outperform other asset classes'. Peter Bernstein recently resurrected this wonderful quote from Keynes. "This long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in the tempestuous seasons they can only tell us that when the storm is long past the ocean will be flat." I think many individual investors are beginning to feel this way. They don't really care if stocks go up in the long run when they are losing 20% per year right now. There must be more to the equation than simply that stocks rise over very long periods. Are stocks attractively valued? What is the risk/reward tradeoff today? The risk/reward tradeoff is always changing but this myopic focus on the long run seems to suggest it never does.

And don't expect time to bail you out of a bad investment either. 'If you buy and hold you will be fine' is another often heard refrain. Most would agree that this is not true regarding a single stock. If you own Enron all the time in the world will not save you. Likewise, if you dramatically overpay for a stock you may not achieve the long run returns either. Ray DeVoe tells the story of one investor he knew that bought RCA near the 1929 peak. He held the stock for 40 years just to get his original investment back! A long holding period does not absolve you of the responsibility to invest carefully. Successful long term investing presumes that you begin with a good investment. If this is true for an individual company it should also be true for a basket of companies like the S&P 500. Therefore, the question must be asked, Does this basket of companies offer a good risk/reward tradeoff over a reasonable time frame, say 3-5 years? If you conclude the next 3-5 years look poor, but in the long run stock always rise, you should consider reducing your exposure. But individuals are often counseled to remain fully invested at all times. They are advised to look past the 'tempestuous season'.

Aside from the damage that can arise from ignoring the short term, the investor and his advisor must face one other huge impediment to long term gains - the investor himself. Fear. An investor's risk tolerance will become a critical factor, perhaps THE critical factor, in whether an individual will actually ride out the occasional bear market and still be investing when the long term gains eventually kick in. History shows that most investors have given up entirely on investing when a secular bear market comes along. The thought process seems pretty straight forward. After the continuous, unrelenting losses of a secular bear market the investor begins to distrust the whole concept of investing. Watching his portfolio go down 50-60%, he concludes 'if I don't sell today, I will have less tomorrow'. Sell. According to Marshall Auerback, 40% of Japanese households owned stock at the peak of their market in 1989. Today 5% of households own stock. Mutual funds in the U.S. experienced persistent net outflows for about eight years after the 1973-1974 bear market. It is a good bet that many of the investors who sold after the '73-'74 bear market missed much of the gains from the bull market of the '80's, and probably much of the '90's as well. Such wholesale abandonment of equities is not the result of poor economic policy or raging inflation but rather the result of investor fear. Perhaps if investors used a shorter time horizon, they would be less likely to buy at market tops and sell at market bottoms. If the occasional periods of poor stock returns were as well known as the long term returns were, the average investor might have been more conservative in the late '90's. He might therefore have suffered smaller losses in recent years and thus be less likely to reach the breaking point and sell out during the current bear market. Paradoxically, a shorter, more realistic time horizon might actually improve an individual's chances of truly becoming a long term investor. If fear drives an investor out of the market, the long run becomes meaningless.

So what is long term anyway? Many professional investors use a 3-5 year time horizon regarding individual investments. Three years may be too brief as it might not even cover an entire bear market. Individuals who hold funds should be well served with a 5-7 year time horizon. This should be long enough to account for the occasional market cycle, but not so long that the individual would overlook a high risk market when deciding on an appropriate asset allocation. Don't overlook the 'tempestuous season' in your investment plans.