Many experienced investors even some who have amassed millions of dollars in assets don’t really understand what is reasonable to expect from
their investments. All too often, they say things like, “I want annual returns of about 20%. But I don’t want to take much risk.” Statements like these
drive money managers to pull out their hair, because they’re not a whole lot better informed than saying something like, “I want to eat nothing but bratwurst and pizza for the rest of my life. But I also expect to consume plenty of fiber and few calories in my diet.” Greed, bad choices, and stubbornness have torpedoed many an investor, but the biggest hurdle to successful investing might be unreasonable expectations.
Over the last 87 years, large-company stocks have averaged annual returns of 11.8%. Over the same period, stocks of small
companies delivered a 16.5% average return. Long-term government bonds returned an average of 6.1% a year since 1926, while Treasury bills—about
the lowest-risk investment available—managed just 3.6% returns. While both types of stocks handily outperformed bonds, the price of that return
was overall higher risk. Small company stocks posted higher highs and lower lows than large companies and bonds, and they were also more likely
than large stocks to see returns vary greatly from year to year. Investors call this type of risk volatility. Of course, bond investors didn’t suffer nearly as
much volatility as stock investors.
If you wish to become a successful investor, commit this concept to memory:
“High risk, high return. Low risk, low return.” Like so many important truths, the investment mantra above is simple to understand, but not always easy to implement. Still, the relationship between risk and return is the cornerstone of investing.
Every investment has ups and downs; nothing charts a straight path. However, some paths are rockier than others. The more risk you take, the greater your chance for a high return—or a big loss. If a stockbroker or financial adviser tells you he can earn high returns with little risk, you’ve probably found the wrong guy to assist you with your investments.