High Returns and Low Risk (Still) Don’t Mix

Sep 2014 //
Risk vs. Volitility
Behavioral Finance

[We’ve] made the point that investors can choose to tolerate characteristic stock market volatility in pursuit of attractive long-term returns, or they can choose to tolerate significantly lower long-term returns in pursuit of more short-term stability.  These are the choices available to investors, but since many don’t understand this tradeoff, they sometimes seek other alternatives.  Consider annuities offered by insurance companies, for example.  Annuities sometimes promise guaranteed minimum returns and equity-linked upside possibilities.  However, insurance companies typically invest their annuities’ funds in stocks, bonds and real estate, and they simply cannot rewrite the tradeoff between expected risk and return.  So it pays to read their fine print.  Guaranteed returns are typically low in comparison to average equity returns, and “equity linked” returns often amount to much less than a one-to-one correspondence with S&P 500 total returns.  Again, insurance companies aren’t magicians.