No risk, no reward

By Carl Richards via nytimes.com   Article

Investors Trying to Beat the System Invariably Are Disappointed

“The closest thing we have to a universal rule in finance is that risk and expected return are related. Once we’ve got a diversified portfolio of investments, we must take greater risk to get a higher return. Risk is mainly a function of how wildly the investment you own fluctuates in value. In other words, in order to get a higher return, we need to deal with something going up and down. Sometimes a lot. That’s the deal we make with the markets, and there’s no real way around it. Every time I see someone trying to figure out a clever way to break this rule, it ends up breaking them.

Stocks, assuming you have a low-cost, broadly diversified stock portfolio, move up and down a lot in the short term, but offer the promise of growth in the long term. Bonds (the short-term, high-quality kind) provide a safe place (relatively speaking) to invest over a short period of time, but their returns barely keep up with the taxes you may pay on them plus inflation over longer periods of time. Cash gives us flexibility without much return. …

In fact, once we understand the deal we’ve made with the markets, we start to realize that these wild swings are the reason we get paid to own stocks. Without those wild swings, the higher returns that stocks have delivered would go away, and all we’d be left with are certificates of deposit at the local bank. No risk there, so no reward. …

Over the last 30 years, stocks have returned, on average, around 10 percent. Bonds have returned roughly 5 percent. These are facts, yet we insist we have the power to change reality. It’s the investing version of trying to make a square peg fit in a round hole.”

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