I often get asked where I’d recommend others invest their assets for the best returns, with the least amount of risk (of course).
“Low-risk, high-returns!” has a certain ring to it, doesn’t it?
Kind of like, oh, I don’t know… “Get rich quick!” or “Free beer!”?
Here’s the thing – risk and returns have a direct relationship. When risk goes up, the potential for higher average returns tend to go up as well (with more volatility and the potential for big declines along the way). This is precisely why the stock market has consistently produced the highest returns over time. An element of risk can lead to healthy returns. There’s a reason why Vanguard lists their risk/reward on each of their funds like this (with less risk/reward and more risk/reward being paired together):
However, too big a risk can often lead to big losses. This is precisely why you should not find a common stock screener and sort or filter for the stocks with the biggest dividend yields. There is almost always a reason why those yields are so juicily high (i.e. the company has a large strategic threat, and/or revenues or profits are dramatically declining and there is legit concern the company will decrease or eliminate its dividend, etc.).
Unfortunately, for those with a low risk appetite, when risk goes down, returns go down too. If everyone could get a 10% return on a bank CD right now, why would anyone invest anywhere else?!
Just look at the current approximate average annual returns of well-known very low-risk investments:
- 1-year CD: 0.88%
- money market account: 0.21%
- interest-bearing checking account: 0.08%
- 5-year CD: 1.44%
- 10-year treasury bond: 2.66%
Nothing to write home about, or fill a retirement account with, eh?
In some cases, an investment will come along and tout that it is very low risk and very high return. When you come across these offers, you’d best be served to turn and run.
Low-risk, high-return opportunities are the stuff of mysterious legend. They’re like a Sasquatch – as many have excitedly claimed to catch a glimpse of one, but nobody has ever come home with the remains.
There’s good reason for this. Due to market forces, low-risk/high-returns don’t stick around. What investor doesn’t want low risk and high returns? As soon as these rare opportunities are found, demand for them increases, which means the price to buy in to these investments also increases. As prices go up, returns simultaneously go down. If you’ve heard about a “can’t miss opportunity”, you’re likely going to miss because you’re already too late to the game to reap the rewards.
This also works the other way. As risk goes up, prices go down as investors flee for safer pastures. As prices go down, potential returns go up. But as alluded to earlier, risk doesn’t always equate to returns. Some high risk investments have the real potential to drastically decline in value or go to zero. They are “high risk”, after all.
Similar principles also apply to business investment. If a business concept requires low barriers to entry (low risk) and gets great returns, more investors are going to rush to that opportunity, which will result in more competition and drive down returns. We live in a very liquid capital environment, so the pace at which supply is meeting demand for low-risk opportunities is lightning fast.
I share this important lesson with you as a precaution. You will undoubtedly get “low-risk, high returns!” pitched to you many times in your life. It’s human nature to be tempted by these so-called “opportunities”. But your hard-earned savings would be better served to stay away. Time, plus a healthy amount of risk is the better path.