A savy investor can earn solid returns.
(photo credit: Adi Benzaquen)
Open up a book on Investing 101 and it will tell you that a stock’s return will
be directly related to its risk. The Investing 101 book states that if you want
to have high returns, you have to take on enough risk that ensures if you are
wrong, it will end up costing you a good chunk of your portfolio.
sit with prospective clients and I ask them about the level of risk they would
be comfortable with, they inevitably say they want high returns and little risk.
Most financial advisers would answer that you can’t have your cake and eat it.
Either you can go for the high returns or the little risk, but there is no way
you can have both.
It seems that most financial advisers may be wrong,
and the clients may be on to something. Last year there was an article in the
Financial Analysts Journal that showed something that flew in the face of
conventional financial planning: Over the 41 years ended in 2008, low-risk
stocks outperformed high-risk ones.
Keep in mind that if you took a few
years, especially years like 2001 or 2008 when the stock market crashed, you
could easily make the case that less-volatile stocks would outperform, but in
good years that shouldn’t happen. That’s what is so surprising about the
research: that in fact over both good and bad markets, the best way to
accumulate wealth over the long term was by investing in stocks with low
This study has been backed up by others. Shannon Zimmerman,
an associate director of fund analysis for Morningstar, was recently interviewed
by Morningstar.com. When asked about his research that also highlighted the
benefits of low portfolio volatility, he said: “That’s true. It does turn out to
be the case that over the course of many decades – and sort of building on some
research that has been done into individual equities that are rolled up into
portfolios – it turns out that less risk, if you define risk as volatility,
actually leads to more rewards. There is a low volatility premium akin to the
small-cap premium or the value premium that investors are more widely aware
“It sort of flies in the face of what people believe, and it seems
counter-intuitive. Seemingly, the more risk you take on, the greater the
potential reward, and there is a way in which that’s true: The more money you
put at stake, if the investment works out, the more you’ll earn. But if you
define risk as volatility – and typically academic researchers are defining it
in terms of standard deviation or beta – if you look at risk through those
lenses, it turns out that the lower beta, the lower standard deviation
investments, tend to perform better over the course of many years.”
that is a bit complicated and technical, Zimmerman is basically saying that
stocks that don’t move around much end up performing better than stocks that
have more ups and downs.
What’s not love? For clients gun-shy about
taking on added risk after a decade that has seen two market routs, this news is
a godsend. For most clients, if they can grow their portfolios over time, but
don’t have to fret over a monthly statement that shows a huge short-term drop,
then all is good.
Zimmerman adds: “So, it turns out that investors use
low-volatility funds better because they... don’t get the willies when the
quarterly report comes, and they haven’t gone... down 15%... in a flat market.
The smoother a ride a fund can give a shareholder, the better they tend to use
And use it they are. A whole slew of new products including ETFs
(exchange-traded funds) have hit the market, and they’re all based on the
low-volatility strategy. Whether it’s an ETF on the S&P 500, emerging
markets or a broad international index, these low-volatility ETFs have seen huge
inflows (billions of dollars) of money since their launch.
should speak with their financial professional to see whether low-volatility
investments have a place in their
firstname.lastname@example.org Aaron Katsman is a licensed
financial adviser in Israel and the United States who helps people with US