The probability of a very poor investment outcome occuring: A. Increases with longer time periods B. Increases with higher equity allocations C. Increases witg lower equity allocations D. A and B but not C
The correct answer and explanation is:
The correct answer is D. A and B but not C.
Explanation:
The probability of a very poor investment outcome tends to increase with longer time periods and with higher equity allocations.
First, longer time periods can increase the chance of experiencing significant negative investment returns at some point. Although investing over a long time horizon generally reduces the risk of loss if measured at the end of the period, the likelihood that very poor outcomes will occur during any shorter interval within that period increases. This is because markets go through cycles of ups and downs. Over longer spans, there is more opportunity for downturns or crashes to happen, increasing the probability of very poor results occurring temporarily.
Second, higher equity allocations typically increase the volatility and risk of a portfolio. Equities (stocks) are generally more volatile than bonds or cash. Therefore, portfolios with higher equity exposure tend to have greater fluctuations in value and a higher chance of suffering steep losses in the short to medium term. This increased volatility makes very poor investment outcomes more probable compared to portfolios with lower equity exposure.
Conversely, lower equity allocations usually reduce the risk of poor outcomes because bonds and cash equivalents tend to have lower volatility and more stable returns. Portfolios with less exposure to equities are less likely to experience severe negative returns, thus lowering the probability of very poor outcomes.
In summary, both longer investment horizons and higher equity allocations raise the likelihood of encountering very poor investment outcomes at some point. Lower equity allocations decrease that risk. This is why the correct choice is D: the probability increases with longer time periods (A) and higher equity allocations (B) but not with lower equity allocations (C).