Confusing volatility and risk could cost you a bundle. Let’s take a look at returns on an investment of $1000 over 50 years from 1958-2007 in five asset classes.
Small cap value: $3,750,000
Small cap growth: $1,380,000
Large cap value: $854,000
Large cap growth: $130,000
CD: $13,800
Isn’t it obvious which is the best long-term investment?
Why small cap value is the best long-term investment
So you don’t have a 50-year investment horizon? Few of us do. How about a ten-year horizon? In any ten-year period from 1958 to 2007, small cap value had much better investment results than a “safe” CD. (See Table below. Green = best result in the given ten years; red = worst.)
Table: How would $1 investment become?
10 year periods
Small Cap Growth
Small Cap Value
Large Cap Growth
Large Cap Value
CD
1958-1967
$5.64
$8.02
$3.22
$5.39
$1.36
1968-1977
$0.97
$2.66
$1.2
$2.64
$1.75
1978-1987
$3.38
$7.84
$3.52
$4.96
$2.41
1988-1997
$2.87
$6.47
$5.38
$5.13
$1.7
1998-2007
$1.53
$3.47
$1.77
$2.36
$1.42
Annual volatility
28.23%
24.05%
17.67%
18.54%
1.7%
Safety paradox
Even though a FDIC guaranteed CD is perceived to be safe, over time, inflation eats away at returns. For the long-term investor - and by that we mean you - small cap value is less risky.
Why do few investors put their long-term money in small cap value? And, when the going gets rough, why do many small-cap-value investors switch their money to CDs?
Here’s why, small cap value is highly volatile (See last row of Table) and volatility makes us anxious and jumbles our judgments.
“Volatility does not measure risk.” -Warren Buffet
Volatility becomes risk only when the investor can’t stand it anymore, and abandons an otherwise safe long-term investment. Typically, volatility is highest and its impact most painful when the market reaches bottom. Not surprisingly, many investors bail out at the worst possible time.
Small cap value: $3,750,000
Small cap growth: $1,380,000
Large cap value: $854,000
Large cap growth: $130,000
CD: $13,800
Isn’t it obvious which is the best long-term investment?
Why small cap value is the best long-term investment
So you don’t have a 50-year investment horizon? Few of us do. How about a ten-year horizon? In any ten-year period from 1958 to 2007, small cap value had much better investment results than a “safe” CD. (See Table below. Green = best result in the given ten years; red = worst.)
Table: How would $1 investment become?
10 year periods
Small Cap Growth
Small Cap Value
Large Cap Growth
Large Cap Value
CD
1958-1967
$5.64
$8.02
$3.22
$5.39
$1.36
1968-1977
$0.97
$2.66
$1.2
$2.64
$1.75
1978-1987
$3.38
$7.84
$3.52
$4.96
$2.41
1988-1997
$2.87
$6.47
$5.38
$5.13
$1.7
1998-2007
$1.53
$3.47
$1.77
$2.36
$1.42
Annual volatility
28.23%
24.05%
17.67%
18.54%
1.7%
Safety paradox
Even though a FDIC guaranteed CD is perceived to be safe, over time, inflation eats away at returns. For the long-term investor - and by that we mean you - small cap value is less risky.
Why do few investors put their long-term money in small cap value? And, when the going gets rough, why do many small-cap-value investors switch their money to CDs?
Here’s why, small cap value is highly volatile (See last row of Table) and volatility makes us anxious and jumbles our judgments.
“Volatility does not measure risk.” -Warren Buffet
Volatility becomes risk only when the investor can’t stand it anymore, and abandons an otherwise safe long-term investment. Typically, volatility is highest and its impact most painful when the market reaches bottom. Not surprisingly, many investors bail out at the worst possible time.
