This column is the first in a 10-part series
No one invests to lose money. Although the past decade or so may have people wondering about that, history does not lie.
In the long run, markets throughout the world have a history of rewarding investors for deploying their capital in proportion to the risk they are willing to take. Their expected returns offer compensation for bearing the various risks involved.
The U.S. stock market is the biggest in the world and gives us statistics that are longer than those in Canada, so I'll use them as an example.
From 1926 through the end of 2012, the entire universe of U.S. stocks gave us an average compound rate of return of 9.63 per cent (as measured by the Centre for Research in Security Prices at the Chicago Booth School of Business).
During the same period, "safe" U.S. one-month treasury bills gave us a 3.53 per cent compound rate of return and inflation averaged 2.98 per cent, as measured by the U.S. Consumer Price Index.
To calculate the "real rate of return", we subtract inflation from the rate of return.
After that bit of basic math, the real rate of return of the U.S. stock market has been 6.65 per cent, while that of treasury bills has been 0.55 per cent.
You've probably seen enough compound interest calculations to realize that 0.55 per cent is going to slowly and steadily get you broke very safely! That's not bad for short to mid-term goals, but it can be catastrophic in the long run.
If we dig a little deeper (and we will in future articles), we also know that the folks who invest in the smallest and most out of favour stocks will do better than those who invest in the biggest and safest companies.
Why? Simply because the market tends to reward investors who take higher risks
An "efficient market" or equilibrium view assumes that competition in the marketplace quickly drives stock or bond prices to fair value, ensuring that investors can only expect greater average returns by taking greater risk in their portfolios.
Lightning-fast information and trading technology has virtually eliminated the advantages once held by even the smartest professional money managers.
In this environment, the best thing that investors can do is to identify the risks they are willing to take, position their portfolios to capture these risks through broad diversification, keep their costs low and stay in the game through the highs and lows.
The long and short is that no one is smarter than the market.
If I take a position that a certain stock is worth more or less than its current market value, I'm essentially claiming to be smarter than the market.
I've come to the blissful realization that I can never do that.
The opinions expressed are those of Richard Vetter, BA, CFP, CLU, ChFC.
Richard is a senior financial advisor with WealthSmart Financial Group/Manulife Securities Incorporated in Richmond. Manulife Securities Incorporated is a member of the Canadian Investor Protection Fund.
