Myth #9 Greater Risk Generates Greater Returns
Financial Myth’s Blog Series
Unfortunately, much of the information relating to money that permeates our thinking as individuals and as a society is based on myths. This misleading information has no factual basis and can actually prevent us from achieving our financial objectives. This week we’re dealing with the fallacy that greater risk generates greater returns.
Follow along with us through the Financial Myths Blog Series. You may be surprised by what you discover about yourself and your financial plan!
Myth #9 – Greater Risk Generates Greater Returns
Some people like to gamble – they want to beat the system and believe they are smarter than the world.
You have to remember that the market is a zero-sum game. There are equally as many losers as winners. It is even worse in Las Vegas, where there are substantially more losers than winners. Why do people rush to Las Vegas when the odds are so bad? They love the risk, the challenge, and the adrenaline rush. I believe it’s somewhat akin to buying a lottery ticket and having a one-in-a-million chance to win. I believe I will win by not purchasing a lottery ticket, while most people think they will win by buying one. Tell me, who is delusional?
In most instances, especially in the stock market, the more risk you take the more volatility you will experience.
The problem we see is that most people are unable to handle it. They get emotional and make rash decisions that lead to lower returns.
Make sure that your risk tolerance accurately represents your internal gut response.
If you invest more aggressively than you can emotionally handle, you will lose money by selling when you should buy. Risk is rewarded over the long term, often taking decades or a lifetime of waiting. Do you have the emotional makeup to do this? If not, take less risk, and you will have better probable returns.
Another risk that does not pay off is one that creates excitement without added value.
Say your goal is to drive to the mountains and go skiing. On the way, you decide to stop at the bridge and bungee jump. You just exponentially increased your risk for that day. The bungee jumping also took time and kept you from getting to the mountain sooner, leaving you with less time to ski. You got less return and took more risk. I am prepared for some of you to say, “I love bungee jumping – it was worth it”. Even so, it did not help you attain your goal (which was skiing). It took you farther away. Investing can be the same. Being aggressive does not guarantee better long-term results. Studies show that 94% of return comes from allocation. So, you can see how important it is to build a well-allocated portfolio.
Just because you take greater risk in the market does not mean you will get a better return for several reasons:
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Your risk tolerance.
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Your emotional makeup.
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The allocation in your portfolio.
What is going to provide better returns?
- A fact-based portfolio.
- A portfolio that fits our risk tolerance.
- Understanding how that portfolio will act, so we are not surprised by movements in the market.
- A goal and long-term perspective.
- Ignore the news! short-term noise could steer us off our long-term plan.
- Proper asset placement.
- Staying systematic, unemotional, and diversified.
So how is your portfolio constructed? Is it based on a promise for quick returns, or is it based on facts, a plan, and a process built around your long-term success?
Today is a good day to be prudent with your investments!
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