Question from a reader: risk premium, volatility and returns

JP asked me: "When investing money, we are always asked about our risk profile (low, medium or high) as an investor. Are the higher risk investment portfolios truly more volatile than low and medium? On the long run, statistically, will higher risk truly pay more? By how much? Is there data/analysis to support this?"

Excellent question. I did see a research that showed two portfolios, one high risk, one conservative and both had the same return on the long run. I can't remember where I've seen that, but the returns where around 10% which looks like the TSX average over a longer term.

The reason I don't want to dig too much into that aspect of this, is that even if in some cases, higher risks would pay more, my investing philosophy and what I want readers to get out of this blog is:

1. lower fees (ETFs, direct low fee brokers) is better
2. lower volatility is better (you sleep better at night)
3. diversification is safer (especially if you achieve diversification in less correlated investments)
   
4. trying to beat the market (indexes) is very hard
5. buy low, sellh high (obvious, but basically, buy when everything just crashed and sell when everybody is excited and buys Nortel at 120$ or buys energy stocks at a time like now)

So reducing volatility would be the first goal, regardless if you have "higher" risk or not. Personally, I diversify with "higher" risks things like gold and real estate (riskier according to some) and commodities. I've done that for a long time and it worked really well for me. Buying Nortel at its top was never part of my plan because it didn't add good diversification and it met my "sell" criteria, not my "buy" one.

A column in MarketWatch summarizes very well what I'm talking about. (I was happy to find this because otherwise I would have had no proof of my philosophy!.) Their title:

"Buying hard assets the easy way

Commodity, real estate funds boost return, reduce risk"

I hope this answers your question, although I know it might not be exactly the answer you were looking for. Feel free to comment to pursue the discussion.