By Public Domain Pictures at Pixabay
I didn't know more risk = more reward was "one of the most famous rules" in investing, but let's say it is. In that case, it's wrong, and the numbers presented in the article below back that up.
There's a flaw in the reasoning: "If you take on more risk, you can expect a bigger reward." And you don't need a study to prove it. More risk and "expect" don't go together. If you assume more risk, you MAY obtain a bigger reward, and you MAY NOT. However, it seems the author is using the word "risk" to mean volatility. And greater volatility doesn't equal greater rewards either.
One of the Most Famous Rules of Investing Might Be Totally Wrong
There is supposed to be one fundamental truth in investing: If you take on more risk, you can expect a bigger reward. With new research suggesting that things may not be so simple, investors may want to adjust their strategies—or at least their expectations—accordingly. (As I've noted this is a bad description of a "rule" that will next be knocked down.)
Boston-based asset manager GMO recently looked at risk and return data for U.S. stocks from 1970 to 2011, and what the researchers found is surprising: The riskiest 25 percent of stocks—those most vulnerable to swings of the broad market—logged an average annual return of just over 7 percent per year. The least-risky 25 percent of stocks returned 10.6 percent per year. On a $10,000 investment over those four decades, the lower-risk stocks would have yielded more than $450,000.
Investors who took on more risk in search of higher returns should be ticked about this new information. Owning a stock whose price moves with the rest of the market makes your whole portfolio more volatile, and it’s reasonable to expect a bigger return in exchange for taking on that risk. But the 40 years of data suggests otherwise—and it’s not a passing trend.
