Not All Risk is Rewarded
I could drive the highway at night going 100 miles per hour without my seat belt on and close my eyes for 60 seconds, and I would have taken a huge risk. But I would in no way, no matter how it turns out, experience a commensurately huge reward.
In the same way, with investing, there are risks you can take that will not always be rewarded. We will discuss the most common ones at our next event: stock picking, track-record investing, and market timing. These risks do not pay off for investors in any measurable or academically notable way. Today let’s look at the ones that do.
There is risk you can accept that is very likely to give you a return greater than other less risky investments. My job is to help investors understand and then harness these rewarded risks.
There are four main risk areas that are regularly rewarded over time.
- Stock vs. bond. Stocks are riskier than bonds. Stocks have consistently paid returns higher than bonds.
- Small vs. large. Small company stocks are riskier than large company stock. Small companies have paid higher returns than large companies over long periods of time.
- Value vs. growth. Value (or low priced) stocks are riskier than Growth (higher priced) stocks. Value stocks returns have been higher than growth stocks.
- (A recent discovery) Profitable vs. unprofitable companies. It has recently been shown that companies that have shown a consistent level of profitability over previous periods will return better than companies that have not.
Good Risk is NOT Enough
Just as important as understanding where rewards come from is what is required of you to realize these rewards. Long-term perspective, disciplined rebalancing, and cash-flow decision making are required to realize the best of the market’s risk-reward story. But remaining disciplined over very long periods of time, on your own, is highly unlikely. You need a coach.
When it comes to investing, know that our clients are coached to NEVER take on unrewarded risk.