That risk and reward are related is one of the first things — if not, the first thing — that investors are supposed to learn. Markets reward investors for risk. Of course, there’s no guaranteed reward — otherwise it wouldn’t be risk — but, generally speaking, the more risk you take, the greater the reward you can expect over the long term.
But, being human, we often either forget, or choose to forget, this fundamental fact. It’s a tendency the investing industry loves to prey on with its seductive marketing and fancy-sounding, and frankly misleading, terms like risk parity, absolute return and downside protection. It knows that people choose to buy a product when they feel good about it, and who wouldn’t feel good about a fund that claims to offer greater reward with less risk?
That’s why it’s so important for investors and their advisers to separate fact from fiction and to get back to basics. As Jason Zweig wrote the other day in the Wall Street Journal: “No matter what kind of investment someone is flogging, you should always remember that high yield and low risk are like oil and water.”
To illustrate the relationship between risk and reward in investing from an evidence-based perspective, I would like to present two videos which we’ve produced for Independence Advisors, based in Pennsylvania.
The first video explains the different premiums that drive investment returns which academics have identified — principally size, value and profitability.
Thank you to Charles Boinske, President of Independence Advisors for commissioning these videos and allowing us to use them. Thank you, as well, to Dimensional Fund Advisors, on whose research the data in this video is based.
Next week, in Part 2, we’re going to be looking at what sort of performance you can expect the different risk premiums to deliver over time.
NOTE TO ADVISERS
Advisory firms may like to know that Independence Advisors has agreed to license its four-part video series Evidence-Based Investing Insights to selected firms that share its investment policy and its fiduciary status.
If you’re interested in having your own branded version of the series, please contact Sam Willet at firstname.lastname@example.org or on +44 121 285 2585. The videos are also available in Dutch and in German.