The Wall Street Journal just reported on a new study that found investment "managers from poorer families tend to beat those from more affluent backgrounds." As the son of a firefighter, my first thought was "I knew it!"
Then, I realized that study made the same mistake I warn investors about, i.e., it ignores risk. Taking a little risk to earn a 6% return is far better than taking a lot of risk to earn the same return. Investors get lust in their eyes about investment returns, ignoring the risk.
Everybody nods their head in agreement and appreciates the reminder, but here's the problem - how do you measure risk? That is a big problem! Currently, the best investment minds use volatility of the stock prices as a measure of risk, such as the Sharp Ratio or the Traynor Index, which are based on a statistical technique called standard deviations, My thought is that they are nice, tidy little calculations that misrepresent risk. There is no adequate risk measure at this time, which makes it impossible to accurately measure risk-adjusted returns.
So, what is an investor to do? Ask yourself if your advisor focuses primarily on risk . . . or return. If an investment manager starts talking about investment performance without first talking about the risk environment, that is a clue. If he/she cannot explain the way he/she assesses risk, that is another clue.
Risk cannot be accurately measured, but that does NOT mean it can be ignored!
Then, I realized that study made the same mistake I warn investors about, i.e., it ignores risk. Taking a little risk to earn a 6% return is far better than taking a lot of risk to earn the same return. Investors get lust in their eyes about investment returns, ignoring the risk.
Everybody nods their head in agreement and appreciates the reminder, but here's the problem - how do you measure risk? That is a big problem! Currently, the best investment minds use volatility of the stock prices as a measure of risk, such as the Sharp Ratio or the Traynor Index, which are based on a statistical technique called standard deviations, My thought is that they are nice, tidy little calculations that misrepresent risk. There is no adequate risk measure at this time, which makes it impossible to accurately measure risk-adjusted returns.
So, what is an investor to do? Ask yourself if your advisor focuses primarily on risk . . . or return. If an investment manager starts talking about investment performance without first talking about the risk environment, that is a clue. If he/she cannot explain the way he/she assesses risk, that is another clue.
Risk cannot be accurately measured, but that does NOT mean it can be ignored!
