Annualized Volatility Nominal Real, After-Tax FIGURE 30.5 Impact of Taxes and Inflation on Risk and Return Source: Nominal and inflation data from Ibbotson Associates; tax adjustments by Goldman Sachs. The riskiness of stocks declines because the absolute amount of tax varies with market returns. Taxes are high in strong markets and low or effectively negative in weak markets. This reduces the volatility in after-tax results. The riskiness of "safe" investments increases because the impact of inflation introduces uncertainty into the future real value of money market and fixed income investments. RISK AND TIME Figure 30.5 shows risk as measured by the volatility of annual returns. The choice of time horizon significantly affects the risk calculation. Longer-term returns are more predictable than annual returns. Random volatility tends to cancel out over time, converging on the expected average return. Furthermore, market returns from one year to the next may not be completely independent events. Market returns have tended to be "mean reverting" during the period we have studied. There is some controversy on this point. However, data from the past 76 years support the mean-re vers ion concept. In particular, long-term cumulative returns have not been as volatile as the annual volatilities would suggest. A total of 76 years of data yields only three independent 25-year periods, and so the statistical support for mean reversion is weak. However, the concept is intuitively appealing.