Is taking fewer risks the key to success?
In the world of investing and beyond, you've probably heard at least a few times that you must take risks to be successful. So, trading in questionable stocks should yield great rewards, right? Wrong, according to MarketWatch financial analyst Brett Arends.
In his column on the website, Arends writes that recent research suggests that one could earn higher returns by taking on little risk. He cites the 2008 study "Case Closed," authored by financial analyst Robert Haugen and Guggenheim Investments strategist Nardin Baker. In it, the pair follow the performance of U.S. stocks since the 1960s. They found that investing in big-value stocks that had less volatility than the rest of the market yielded the same rewards as more risky stocks.
Haugen and Baker also suggested that an optimized portfolio of safer stocks might have beaten the market from 1965 to 2007 by as much as five percentage points per year.
How could this be possible? Arends offers a simple explanation.
"The most important factor in investment performance is the price you pay for stocks," Arends wrote. "Investors in the main tend to pay too much for sexy 'growth' stocks with exciting stories, and undervalue the virtues of dull, boring, slow-growth companies — even though they may have tons of cash flow today and tomorrow."
This strategy results in a cautious trader gaining an edge over a long period of time by going against mainstream investors. This also suggests that playing the long game may be the best way for individual investors to find success.
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