Over the past few years I’ve repeatedly pointed out in my retirement blog, web posts and publications that “risk and reward are traveling companions”. This means that the promise of high returns invariably carries increased risk. There are no exceptions to this immutable law of investing, yet savers/investors constantly forget this truism.
In recent months the alleged Madoff Ponzi scheme has been front page news. The attraction was the promise of higher than normal returns, yet those who entrusted their money to Madoff were shocked to learn they may lose their money. In recent days another alleged multi-billion dollar scandal involving Stanford Financial Group is capturing the headlines. Again, the attraction was the promise of high returns when other safe investments were paying just a fraction of those offered by Stanford. In both cases there were years of above-average returns reported. It is amazing there were no regulatory investigations and no whistle was blown by sophisticated investors. Thus, not only do average savers/investors forget about the risk-reward equation but so do government regulators, watchdog agencies and supposedly savvy financial professionals.
The following point can’t be made to strongly: when rates of return, promised or actually realized, are higher than you should otherwise expect, so is the risk. No doubt you’ve heard individuals brag about high returns from investing in gold, trading foreign currencies or astutely picking good stocks, yet seldom do they mention – or even realize – that the risk was comparably high. Just because they “lucked out” does not diminish the risk. If you frequent horse races, you know that betting the long odds (high risk) may result in high pay-offs (return) but mostly such bets lead to losses. Why is it that horse racing handicappers make the connection but investors don’t?
Do some astute investors do better in the market than others? Yes they do because of better analytical skills, a knack for finding hidden values or interpreting emerging trends…but to my knowledge there is no one that can avoid losses one hundred percent of the time. For example, Warren Buffet has a lifetime record of successful investing, yet in the current downturn he has not escaped paper losses nor has he during his career always avoided mistakes. If your broker or financial advisor says you’ll make above-market returns by following their advice, just remember that the traveling companion of high returns is always high risk. If you think that government regulators or the Financial Institutions Regulatory Authority (“FINRA”) will protect you, just remember Madoff and Stanford. There are no exceptions to the risk/reward truism and you are foolish to rely on someone else to protect your interests. So when you hear “high reward”, caveat emptor.
Shelby J. Smith, Ph.D.
Related Topics by Dr. Shelby Smith: Risk and Reward are Traveling Companions (eReport PDF & Video Seminar), You, Taxes and Retirement (eReport PDF & 10min Video), Fixed Annuities: A Good Option for Bad Times (Video Seminar).