The majority of the people or academics believe that as returns increase, the risk undertaken will be correspondingly increased as well. They believe that to achieve more return, you have to take on more risk. This is only true in an efficient market, but an efficient market does not exist in the real world.
The reality is that in an inefficient market, value investing offers not only less risk but more return. This truth doesn’t fit neatly onto the diagonal risk-return line, but it is the truth nonetheless.
Barrow Hanley, a global leader in value investing, has also proven over the past thirty years that you do not need to take high risks to achieve high returns. The firm continues to operate under the belief that fundamental research and a bottom-up approach to investing yields the best results for them.
Hence it is not the higher the return, the higher the risk. What is true is the higher the financial intelligence, the lower the risk.
Again, the possibility of being able to achieve a good risk to return tradeoff is evident from investors that are able to achieve good and respectable sortino ratios over time in their portfolios. An investor that has a better sortino ratio than another is more competent in maximizing returns per unit of downside risk undertaken.
It is important to be a critical thinker in the financial markets. I realize that to do well, one must learn to avoid the conventional wisdom of the crowd. There are many concepts that I learned in finance 101 and continue to be taught in programs such as CFP that were hard to swallow when I finally understood that in practice it works differently.
There are many concepts that we learn in school and continue to be portrayed in mainstream media that are hard to swallow or feel unpleasant if you learn that in practice it works differently. Because until one is able to do so, it is always more comforting to assume or believe that it is impossible to do so. It is nice to think that the market can’t be beaten, if I don’t know how to. It is in us, humans, to want to avoid such conflicting and uneasy feelings of cognitive dissonance by taking the easy way out. And if almost everyone says so, it can’t be wrong.
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