“No Risk, No Reward”

This week I want to talk about one of the old­est chest­nuts in the invest­ing play­book. “No risk, no reward.”

Investo­pe­dia — where most peo­ple land when they’re start­ing out — tells you “the poten­tial return ris­es with an increase in risk”.

Of course it’s true — there’s always a risk asso­ci­at­ed with invest­ing.

But I think the way this trans­lates into the minds of some investors is “the high­er the risk, the high­er the reward” — and we all want high rewards. So there­fore we think we need to accept high risks.

And that’s a prob­lem in a cou­ple of ways. Either because peo­ple don’t end up invest­ing because they don’t want to take high risks, or because they do take high risks and end up los­ing their shirts.

The truth, of course, is that suc­cess­ful invest­ing does­n’t require tak­ing high risks. In fact, it involves hav­ing strate­gies in place to min­imise your risks while at the same time max­imis­ing your returns.

Let’s look at some data.

In 2011, three researchers — Bak­er, Bradley and Wur­gler - ran the num­bers on US stocks going all the way back to 1968. They sort­ed them by volatil­i­ty — volatil­i­ty just being the tech­ni­cal word for how wild the ride is — and then fol­lowed a sin­gle dol­lar invest­ed at each end of the spec­trum, right through to the end of 2008. 41 years.

Their con­clu­sion?

“Con­trary to basic finance prin­ci­ples, high-beta and high-volatil­i­ty stocks have long under­per­formed low-beta and low-volatil­i­ty stocks.”

BBW con­clud­ed that a dol­lar in the low­est-volatil­i­ty stocks — the bor­ing ones — grew to $59.55.

A dol­lar in the high­est-volatil­i­ty stocks — the white-knuck­lers, the ones that are sup­posed to pay you the most — end­ed up worth… 58 cents.

Over four decades, the high-risk stocks LOST mon­ey while the bor­ing ones went up near­ly six­ty­fold.

And before any­one writes in with “that’s just one study, one mar­ket, one stretch of years” — oth­er stud­ies went look­ing for the same thing and found it every­where they looked.

Then why does every­one still believe in high risk, high reward?

Two rea­sons.

One — we love a lot­tery tick­et. Peo­ple over­pay for the dream of the 10-bag­ger the same way they hand over a cou­ple of bucks for Power­ball, know­ing full well they prob­a­bly won’t win. All that demand push­es the excit­ing assets up to prices that qui­et­ly guar­an­tee rub­bish returns from there on. Com­mon wis­dom is that you can afford to “take a punt” on cryp­to or gold or the lat­est hype stock, and, worse still, you’re a com­plete mug if you don’t.

Two — the pro­fes­sion­als can’t help them­selves. Most fund man­agers aren’t allowed to bor­row mon­ey to gear up a port­fo­lio of safe, dull stocks. So to look like heroes against their bench­mark, they pile into the volatile names instead, and bid them up even fur­ther. The myth sur­vives because the peo­ple being paid to know bet­ter are paid to keep feed­ing it.

Tony has nev­er once told me to buy some­thing because it was risky enough to be worth the gam­ble. There’s no box on the check­list for “is this ter­ri­fy­ing enough?”. The check­list does the oppo­site. It goes hunt­ing for qual­i­ty — prof­itable, well-run, audit­ed busi­ness­es that throw off cold hard cash — and it only buys them when they’re cheap.

We don’t set out to buy low-volatil­i­ty stocks. But screen for bor­ing, prof­itable com­pa­nies trad­ing below what they’re worth, and have a guess where you wind up? Down the calm end of the mar­ket. That isn’t to say we don’t have some unde­sired excite­ment now and again — the occa­sion­al African gold min­er whose C‑suite becomes the guest of a mil­i­tary coup for a few weeks — but we don’t go seek­ing them. And we have rules in place to get us out quick smart if we stum­ble into one.

That’s not luck. That’s the whole idea.

And you don’t have to take my word for any of it. The Dum­my Port­fo­lio is pub­lic — we pub­lish the num­bers so any­one can check them. From 2020 to 2025 it returned 16.8% a year against the ASX 200’s 8.2%. Rough­ly dou­ble the mar­ket. Not by white-knuck­ling it through the spec end of the ASX. By being relent­less­ly, prof­itably bor­ing.

Min­imise your risk — by buy­ing prof­itable com­pa­nies at a dis­count, and then hav­ing rules in place for when to get out if things go back­wards.

Max­imise your reward — by hold­ing those com­pa­nies as long as you can, let­ting your flow­ers bloom, let­ting the growth com­pound, and only sell­ing them when the rules force your hand.

Think of it in terms of trans­porta­tion. You want to trav­el from one coun­try to anoth­er. You want to get there as fast as pos­si­ble, because trav­el­ling is uncom­fort­able and annoy­ing. Do you take the high­est risk mode of trans­port? Are you jump­ing in the fastest thing that moves? Jump­ing on one of Elon’s lat­est rock­ets, that tend to blow up on launch? Prob­a­bly not. You’re going to find a rea­son­able bal­ance of speed, com­fort and safe­ty. You know that fly­ing involves risk, but you don’t want to take more than you have to. Invest­ing should be no dif­fer­ent.

min(risk), max(reward)

---

---

QAV Myth Killers is a week­ly col­umn in the QAV newslet­ter, tak­ing apart a piece of
invest­ing con­ven­tion­al wis­dom. Read the series, or
get it by email every Fri­day.

Gen­er­al advice only. Space­craft Pub­lish­ing Pty Ltd
trad­ing as QAV is a Cor­po­rate Autho­rised Rep­re­sen­ta­tive (CAR 001292718) of MF & Co.
Asset Man­age­ment Pty Ltd (AFSL 520442). This is gen­er­al infor­ma­tion and does not take your
per­son­al cir­cum­stances into account. See our
dis­clo­sure.