For Individual Investors Risk-Free Investment Money Is Fantasy Money
Securities with low investment risk and high investment returns are just fantasies.
No “risk-free” investment money is consistently and reliably available to individuals. Luck dominates skill in the securities markets. Clever investment selection is vastly over-hyped, and only the promoters tend to benefit. On average over long periods, investors get paid risk premiums, because they put their money at risk. If they control their costs, they get to keep most of these risk premiums.
Securities markets pay risk premiums and nothing more. While risk premiums that have been paid historically on asset classes have been highly variable and unpredictable, long-term averages demonstrate their existence. (See: What have average investment asset class risk premiums been over long periods? and How stable have common stock equity risk premiums been over time?)
In general, you should expect compensation only for some of the investment risks that you might bear. An optimal investment strategy is one that attempts to capture market risk premiums and to avoid the unnecessary and unproductive investment risks associated with individual securities. Someone will capture the risk premiums that the securities markets will pay. It might as well be you. (See: Asset class investment risk premiums — your reward for taking investment risk)
Suboptimal strategies are more likely to give these market risk premiums to someone else. Variations in returns surrounding the market return are largely a matter of luck. The more active an investment strategy is, then the wider the expected performance variation will tend to be. Competitive securities markets are real-time auction markets that make many smart people just average, and luck dominates skill. (See: Introduction to investment valuation and securities risk)
To believe that the securities markets will pay you more means that the securities markets will pay less to someone else. There is no magic money. Every ‘beat-the-market’ notion requires a patsy. Are you really likely to win consistently over the long term, because of a clever security selection method, a hot sector rotation strategy, or buying companies reported prominently in the media? How can you consistently win in these securities auction markets, when future asset values are fundamentally unknowable and your strategies duplicate those of so many others?
When luck overwhelms skill in investing, each individual needs to assess realistically whether he is likely to be among that very small minority who might possibly have superior investment management skill. Recall the saying from gambling: “If you look around the poker table, and you cannot identify the sucker, then it is you.”
If there is such a thing as easy investment money, it is the money that naive individual investors keep giving and giving to more sophisticated professional investors through excessive investment fees and expenses. Many investors continually squander a significant portion of their returns by naively overpaying to those who promise superior returns, but who will not deliver. (See: Excessive investment costs are a huge problem for individual investors)
The more active an investment strategy is, then the higher the associated investment costs tend to be. Higher variability of outcomes and higher costs are a recipe for both missing and under-achieving your goals. In addition, because of the higher taxes associated with more active strategies, your net performance is likely to be even lower.
Is it time for you to get off your personal investment hamster wheel and think more clearly about your lifetime investment strategy? If so, sign up to our RSS link in the side column and stay tuned for more rational information about personal financial planning and investing.
Tags: financial planning
Personal Financial Planning
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- 2006 and 2007 Personal Income Tax Rates for the 50 States and DC (
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If you want to know about specific U.S. state personal graduated [...])
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Because short-term trading is a zero sum game (before costs) played against other well informed traders, greater turnover is far more likely on average to result in lower fund returns instead [...])
- Conclusion of the Biggest Personal Finance Story of the Past 30 Years ( < <-- Go to Part 4
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- My Treasure Is Taken by My Credit Card Company (
PIRATES OF THE CREDIT SEA - Part 1: My Treasure Is Taken!
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The Scudder Equity 500 Index Fund (BTIEX) and the DWS S&P 500 Index Fund (SXPAX)
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- Do Not Get Fooled by Superior Historical Investment Performance (
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Choosing only from among mutual funds and ETFs that have performed very well in the past can lead to significant selection mistakes and inferior personal portfolio returns
Previous superior or average fund performance simply does not predict similar fund performance [...])
- Publish your blog news articles on traditional media center and newspaper websites (
An easy way to publish and syndicate your best news articles on some of the big news and media websites
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- Fund Authority Scores for Stock ETFs and Mutual Funds – Fund maturity and operating efficiency (
Fund Authority Scores rate mutual funds and ETFs on the most important economic factors affecting long term diversified stock or equity investment fund performance. This article explains the investment fund maturity and operating efficiency factors.
<<-- Go to Part 2
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