Step 8 - Riskese


UNDERSTAND HOW RISK, RETURN, AND TIME ARE INTERCONNECTED

Lawyers speak legalese and the best investors speak riskese. Learning the language of riskese requires investors to have a basic understanding of the concepts of risk, return, time, and correlation. Understanding riskese is essential for successful investing. Most investors chase the short-term returns of stocks, markets, managers, and styles, never truly understanding the impact of risk, time, and correlation on their investments. The more fluently you speak riskese, the higher your risk capacity, risk exposure and expected returns.

 

Index funds investors are optimally rewarded for understanding and shouldering stock market risk. In fact, the very reason investors should expect to earn a return is because of the risks they take. The key is to take the risks that have shown to compensate investors and to diversify away uncompensated risks. Stock concentration, fund manager speculation, performance chasing, market timing and sector concentration are uncompensated risks that carry no increased expected return.
The beneficial relationship between risk and return for indexers is clearly set forth in the Risk Reward Optimization chart shown below. The chart plots the risk and return characteristics for the 20 IFA Index Portfolios and the IFA Indexes for the most recent 50-year time period through December 2008. As you can see, not all risks are compensated. For example, the Large Growth, Small Growth and Nasdaq Indexes carry significant risk, but do not carry optimized returns. In contrast, the IFA Portfolios have shown to enable investors to reap optimal rewards for the risks they take. This is why institutions should take on as much of the right risks as their risk capacity allows and just hold on.

 

 

Additional Charts and Graph from Step 8


Step 8		 Standard Deviation
F8-1
Standard Deviation		 Risk Reward Optimization Chart
F8-1 A
Risk Reward Optimization Chart		 Comparison of Several Investments
F8-1 B
Comparison of Several Investments		 High Volatility
F8-2
High Volatility		 Low Volatility
F8-3
Low Volatility
  Probability Distribution of Two Dice
F8-4
Probability Distribution of Two Dice		 High Volatility Index Portfolio: Distribution of Monthly Returns
F8-5
High Volatility Index Portfolio: Distribution of Monthly Returns		 Low Volatility Index Portfolio: Distribution of Monthly Returns
F8-6
Low Volatility Index Portfolio: Distribution of Monthly Returns		 Difference between Mean Reverting and Non-mean Reverting Outcomes
F8-7
Difference between Mean Reverting and Non-mean Reverting Outcomes		 Probability Distribution
F8-8
Probability Distribution
  Explanation of 12 Years Rolling Periods
F8-9
Explanation of 12 Years Rolling Periods		 Monthly Rolling Period Analysis
T8-1
Monthly Rolling Period Analysis		 Riskese
F8-10
Riskese		 Concentration Risk: One Stock vs Indexes
F8-11
Concentration Risk: One Stock vs Indexes		 Distribution of Rolling Returns over 50 years - IBM
F8-A
Distribution of Rolling Returns over 50 years - IBM
  Distribution of Rolling Returns over 50 years - GM
F8-B
Distribution of Rolling Returns over 50 years - GM 		Distribution of Rolling Returns over 50 years - DIS
F8-C
Distribution of Rolling Returns over 50 years - DIS		 Distribution of Rolling Returns over 50 years - GE
F8-D
Distribution of Rolling Returns over 50 years - GE 		Distribution of Rolling Returns over 50 years - IFA 100
F8-E
Distribution of Rolling Returns over 50 years - IFA 100 		Diversification, Risk and Expected Return
F8-12
Diversification, Risk and Expected Return
  Dimensions of Stock Returns
F8-13
Dimensions of Stock Returns		 Average Annual Returns of the Fa,a/French Three Risk Factors
F8-14
Average Annual Returns of the Fama/French Three Risk Factors		 Market Risk Factor
F8-15
Market Risk Factor		 Risk vs Return for Size Deciles of US Stock Market
F8-16
Risk vs Return for Size Deciles of US Stock Market		 Relationship between Expected Return and the Three Factors of Market, Size, and Value
F8-17
Relationship between Expected Return and the Three Factors of Market, Size, and Value
  Estimated Average Expected Return Over Market Return for Index Portfolio 90
F8-18
Estimated Average Expected Return Over Market Return for Index Portfolio 90		 The Fame/French Five-Factor Model Explains the Difference Between Investing and Speculating
F8-19
The Fama/French Five-Factor Model Explains the Difference Between Investing and Speculating		 Value vs Growth in the US
F8-20
Value vs Growth in the US		 Does it Pay to Extend Bond Maturities?
F8-21
Does it Pay to Extend Bond Maturities?		 Risk and Return of Fama/French US Indexes over 78 years
F8-22
Risk and Return of Fama/French US Indexes over 78 years
  Roller Coaster of Risk and Return: Index Portfolios
F8-23
Roller Coaster of Risk and Return: Index Portfolios		 Roller Coaster of Risk and Return: Small Value Indexes
F8-24
Roller Coaster of Risk and Return: Small Value Indexes		 Value vs Growth in the US
F8-25
Monthly Returns Over 50 Years 		Does it Pay to Extend Bond Maturities?
F8-26
Quarterly Returns Over 50 Years 		Risk and Return of Fama/French US Indexes over 78 years
F8-27a
Annual Returns Over 50 Years
  Risk and Return of Fama/French US Indexes over 78 years
F8-27b
Annual Returns Over 50 Years -Updated for October 08		 Roller Coaster of Risk and Return: Index Portfolios
F8-28
5-Year Annual Rolling Period Returns Over 50 Years		 Roller Coaster of Risk and Return: Small Value Indexes
F8-29
10-Year Annual Rolling Period Returns Over 50 Years		 Portfolio 90 Performance Data
F8-29a
20 IFA Index Portfolios and S&P 500 Rolling Period Performance		  
 
F8-30A
Percentage Days with Gains Versus Annual Return of S&P 500 Index
F8-30B
Percentage Days with Gains Versus Years of S&P 500 Index		 The Emotions of Investing
F8-30
The Emotions of Investing		 S&P 500 vs Treasury Bills
F8-31
S&P 500 vs Treasury Bills		 20 Index Portfolios Risk Reward Optimization
F8-32
20 Index Portfolios Risk Reward Optimization

 

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