Why a New Study Says Your Investing Strategy May Be All Wrong
You spend a lot of time learning how to invest. After all, if you don’t get it right, your margaritas-on-the-beach retirement dreams could go down the drain.
But what happens when you’ve learned the rules and suddenly you hear that conventional investing wisdom has been turned on its head?
Well, that’s what’s happening now in finance circles. You have probably heard us say over and over that higher risk investments, over time, have the potential to generate higher returns.
Well, we’ve got a bombshell for you today: New research demonstrates that, over the past few decades, conservative investments have performed better than aggressive ones. Say wha … ?
Risk: Hard to Define, Easy to Identify
When we talk about conservative investments over aggressive ones, one of the main differences between them is that conservative investments have little risk, and aggressive ones have a lot of risk. So, why would anyone go for the aggressive ones, if the chance that you’ll lose your money is higher? They do it because high-risk investments have long been thought to also have a higher potential for greater rewards.
The problem is, though, that few experts agree on what risk is. Risk is like funny–you can’t necessarily define it but you know it when you see it. A common technique is to look at an investment’s volatility as one measure of risk. Volatility measures how prices careen, like an awesome roller coaster ride, over time. The more unpredictable its prices are, the riskier an investment seems.
And so it was.
Much research was conducted, experiments run and Nobel Prizes given for something we all take as fact today: Riskier investments are supposed to perform better over long periods of time.
But a recent study by independent researcher Robert Haugen and Nardin Baker, Chief Strategist of Guggenheim Partners Asset Management, turns that understanding on its head. Over the past 20 years, investments that didn’t fluctuate a whole lot ended up performing better than those that did.
In other words, owning more aggressive investments wasn’t worth the gut-wrenching ride watching them go up and down.
So does this mean should all revamp our investing strategies?
Does Boring Beat Sexy?
In short, no. When you see the details of the study, you’ll understand better why:
- The study split stocks from all over the world into ten groups, ranked by their risk (volatility).
- Returns were calculated for the time period 1990-2011, which included the tech bubble crash in 2001 and the financial crisis of 2008.
- For U.S. stocks, the least volatile period during that time averaged 12% returns while the most volatile lost 7%.
But as you can see, the study ended just three years after the Great Recession began … right at the time when risky investments were at a low.
Why Conventional Wisdom Wasn’t Completely Wrong
What it boils down to is this: The 20-year period used in the study is actually a very short time frame to peer into a financial microscope. And in this case, the study period ends at a time when all risky investments were way down.
To get a better view on how risky investments perform, you’d need to look at many decades of returns. There’s plenty of research out there that shows over longer periods of time–say, 40 or more years–riskier investments, in general, return more than safer ones.
What You Should Do
This whole discussion around risk is a great opportunity to look at yourself, reflected in the mirror of your portfolio, and really determine what kind of investor you are.
Are you a panicky investor, checking the prices of your investments too frequently and buying when the market is doing well and prices are high, and selling when the market is doing poorly and prices are low? If so, you may want to think about moving some of your money into funds that aren’t sexy but are built for the long haul. In theory, this could hurt your expected gains over the next 40 years, but since your nerves would likely keep you from buying and selling at optimal times, in reality, you’ll get out ahead.
What about if you’re investing for a shorter term, like ten years? With all the volatility in the market from global uncertainty, take a good hard look to determine whether making big bets on the future is worth it. Being defensive in the stock market–in other words, taking a conservative approach–has performed just fine.
Whatever type of investor you are, always remember you’re dealing with real money here … your money. It pays to be prudent. This research just confirms that slow and steady investors can also win the race.