06-01-2014, 06:28 PM
Low risk investments are boring, slow to watch and will never get you rich. True story. But low-risk investments could be just the magic bullet that many of us need.
With $100,000 (that's alot money for most of us), guess how long you take to make you a millionaire? 25 freaking year! And that is assuming a 10% return every single year, something that is very impressive even for top fund manager.
Now, what happens if you start to lose money?
"First of all, imagine I have $100 and I invest in Fund A that returns an average of 5% a year. After three years I might have as much as $115.76. That's just $100 * (1.05)^3. But I might have less. Why? Compounding. Imagine Fund B, which also returns an average of 5% a year. But Fund B takes a wild ride – up 5% in its first year, then up 40%, then down 30%. That's still an average of 5% a year. But at the end of the three years my $100 in Fund B is worth only $102.90. That's a simple effect called “variance drain” (Messmore, Tom, “ Variance Drain,” Journal of Portfolio Management, Summer, 1995). Basically the rate that your money compounds and grows over time is equal to the average return (that 5% in our example) minus half the variance (or variability) in the returns. That variability in returns really impacts your ability to grow wealth over time."
Read http://www.stokflok.com/content/why-does-low-risk-strategy-outperform for full article.
In simple words, compounding makes you richer. The more losses you make, the harder it is for you to retire comfortably.
What do you think about this?
With $100,000 (that's alot money for most of us), guess how long you take to make you a millionaire? 25 freaking year! And that is assuming a 10% return every single year, something that is very impressive even for top fund manager.
Now, what happens if you start to lose money?
"First of all, imagine I have $100 and I invest in Fund A that returns an average of 5% a year. After three years I might have as much as $115.76. That's just $100 * (1.05)^3. But I might have less. Why? Compounding. Imagine Fund B, which also returns an average of 5% a year. But Fund B takes a wild ride – up 5% in its first year, then up 40%, then down 30%. That's still an average of 5% a year. But at the end of the three years my $100 in Fund B is worth only $102.90. That's a simple effect called “variance drain” (Messmore, Tom, “ Variance Drain,” Journal of Portfolio Management, Summer, 1995). Basically the rate that your money compounds and grows over time is equal to the average return (that 5% in our example) minus half the variance (or variability) in the returns. That variability in returns really impacts your ability to grow wealth over time."
Read http://www.stokflok.com/content/why-does-low-risk-strategy-outperform for full article.
In simple words, compounding makes you richer. The more losses you make, the harder it is for you to retire comfortably.
What do you think about this?
