Does Risk Relate to Return?

John Hussman quoted OakTree Capital’s Howard Marks this week:

We hear a lot about ‘worst-case’ projections, but they often turn out to be not negative enough.. most people view risk taking primarily as a way to make money. Bearing higher risk generally produces higher returns. The market has to set things up to look like that’ll be the case; if it didn’t, people wouldn’t make risky investments. But it can’t always work that way, or else risky investments wouldn’t be risky. And when risk bearing doesn’t work, it really doesn’t work, and people are reminded what risk’s all about.

I once believed in efficient markets and that risk and return were related, i.e. the more risk you take the higher your return will be (if you wait long enough and regardless of the price paid). I no longer buy into this line of thinking as the evidence to support it is weak and getting weaker and the evidence against is vast. My objective as an Investment Advisor is to attempt to properly align risk and return – meaning that I need to look for risks that have the possibility of being adequately compensated (and then relate that back to the individual client). Just because one buys stocks it doesn’t mean they will return more than bonds or another asset class because they may fluctuate more. As Marks stated, if a risky investment where a sure thing, it would cease to be risky.

Below is a chart reproduced from John Hussmans latest weekly commentary that relates a given level of the S & P 500 to a given projected return – its not pretty.

Projected returns at given levels of S & P

Scott Dauenhauer CFP, MSFP, AIF

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2 thoughts on “Does Risk Relate to Return?”

  1. If a fixed account was included with the 500, risk is lowered and returns are increased according to William Berstein’s work. Its what protfolios do, not what a single asset class does. A fool would have all their money in the 500.

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