Michael on July 26th, 2007
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You: How can I increase my investment returns without increasing my risk?

Gary: No problem. The answer, my good friend, is a variable universal flexible-life totally guaranteed–

Oh, stop the madness. Look, there are very few guarantees in investing. But several decades of investment history make the following a virtual fact:

The less risk you take, the lower your expected return.

Or, said another way:

To increase your expected return, you must take more risk.

Now it is true that there are strategies such as asset allocation and diversification (discussed in Beyond Paycheck to Paycheck and in future posts) which allow someone currently inefficiently invested to possibly reduce their risk while increasing their expected future returns. But those strategies are most meaningful for those that are not yet invested efficiently. For those who are, or for those who have not begun to invest, the two rules centered above apply. Big time.

You: So what’s that mean?

Probably nothing you can’t handle. It basically means that you’ll need to accept the natural day-to-day fluctuations in the value of your investments in order to achieve the higher rates of return that most long-term investment strategies can provide.

You: Can you boil it down further? Like in English?

Sure. It means more days, weeks, months, and even years when you actually end with less money than you started with. There is no guaranteed investment home run, so don’t waste time looking for it or listening to the guy who says he has it. If something has the potential to be a grand slam, it also has the potential to be a strikeout. And given such a scenario, I’d bet on the strikeout.

Gary: That’s because you’re a pessimist.

That’s because I’m a realist.

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