Investors Unknowingly Take the Wrong Risks

Some investors tend to avoid risk when it comes to their investments. They want high returns with low risks. But avoiding risks positions investors to avoid returns. Some take on too much risk, while others take risks that just haven’t been properly rewarded. All of these behaviors are at the crux of the poor performance many investors experience. Risk should be embraced in appropriate doses that match an investor’s risk capacity. There is a right amount and type of risk for every investor. Risk provides opportunity, and a taste for appropriate risk is a good thing.

As was shown in Step 9, certain asset classes, such as small and value, have had a long history of sufficiently rewarding investors for the risks associated with them. However, there are also several asset classes that carry risk but have been inefficient in delivering returns commensurate with the risks taken. This kind of risk is not worth taking. As such, many investors struggle to develop an asset allocation that captures the right blend of the markets that have maximized returns at given levels of risk. A case in point: many investors seem comfortable investing in companies that are best described as glamour or large growth stocks, presuming they perform better than small or value stocks. These investors would be surprised to learn that growth companies actually have a poor history of delivering risk-commensurate returns. Commodities, private-equity, long-term bonds and technology stocks have also failed to historically maximize returns for risks taken. Failing to understand which blend of investments are worth their risk could cause investors to earn lower returns than they could if they simply bought, held and rebalanced a blend of indexes that optimizes returns at a given level of risk. 

Step 11RiskRewardWrong RiskAsset Allocation