The Low-Risk Anomaly
I ran across an interesting article this week that was published in early 2011 in the Financial Analysts Journal (FAJ). The article is an academic study on the long term returns of investing in high-risk versus low-risk stocks. The study was conducted by three professors of finance/economics who are also asset managers. If you have been regularly reading this blog, the conclusions of the study will not surprise you as I have been preaching an approach to stock market investing that is consistent with the results of their study. With this study, you no longer have to take my word for it.
The study is very academic but includes a lot of discussion about behavioral finance which makes for some interesting reading into why people are not as successful at investing as they could be. For those of you who are interested, you can read the entire article here. But I should warn you, there are formulas with Greek letters in the study.
For those of you who do not want to read the article, I will summarize their basic conclusions:
- Contrary to popular belief, over the long term, lower volatility stocks will actually provide higher returns than higher volatility stocks,
- Not only will lower volatility stocks provide higher returns, they will do so with lower risk.
In other words in 1996 you would have been better off financially to invest in Johnson & Johnson, Proctor & Gamble, and Exxon-Mobil rather than Global Crossing, AOL, and Pets.com. Ok, maybe that’s not a fair comparison (but I am sure many of you did buy shares of those stocks in the 1990s). But what the above study suggests is in the year 2030, a $100,000 portfolio invested today in boring stocks like Abbott Labs, Colgate-Palmolive, and McDonalds will be worth much more than a portfolio full of high volatility stocks like Google, Facebook, and Netflix. And as an additional benefit, the boring portfolio will allow you to sleep better at night.
And, if you are like me, you will let the dividends of the boring portfolio stocks compound year-after-year increasing your share totals until you are ready to retire. At that point your dividend income could be high enough to let you retire before age 65.
Investing is not about getting rich quickly; it is all about getting rich slowly (but surely).
Did you enjoy this post? Why not leave a comment below and continue the conversation, or subscribe to my feed and get articles like this delivered automatically to your feed reader.
Comments
No comments yet.
Sorry, the comment form is closed at this time.