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Re: [sharechat] Risk vs Return

From: "Maria Smith" <>
Date: Thu, 10 Jun 2004 18:43:10 +1200

It has taken me some time to come to the same conclusion

I have recently reset my investment strategy and have been selling any
shares where the company concerned is not making a profit or paying a

The only trouble is that some of these are no longer worth selling


-----Original Message-----
From: <>
To: <>
Date: Tuesday, June 08, 2004 5:44 PM
Subject: [sharechat] Risk vs Return

There are a lot of outspoken thinkers on this forum who put forward the
view, either stated or implicit, that you will never get a decent return
you are prepared to take a good deal of risk.

Taking an overview of the investment spectrum, I tend to agree with them.
There is a fair amount of evidence out there that shares have
outperformed property in the long term as an investment.  Likewise
property has outperformed fixed interest investments.

However if we try to take this 'risk return' theory to that corner of the
investment spectrum we call 'the sharemarket' then the theory is on
somewhat more shaky ground.    I refer here in particular to the more
speculative shares that tend to get more than their fair share of limelight
this forum.

I'll cut here to an article that appeared in  Motley Fool in April by


Beat the Market With Less Risk
By Mathew Emmert
April 12, 2004

This article has been updated since its initial publication on Dec. 1, 2003.

There's no question that dividend-paying stocks have been less volatile
(read: less risky) than their stingier brethren over the years. In fact,
tend to contribute little more than 10% of the volatility of the market as a
whole while producing market-beating returns. What's this? You mean you
can get better returns with lower risk just by purchasing dividend-paying
stocks? You betcha.

The standard line in relation to investment risk is that those who take on
more risk are destined to receive more reward. While this is largely true,
it's only true to a certain extent. We as investors have a tendency to
dramatically over-estimate the amount of risk that's required to achieve
respectable returns.

Indeed, at a certain point, each incremental unit of risk that you take
actually produces a smaller amount of return. This is largely because, as
you start to swim deeper and deeper into the risk pool, you have fewer
winners and more failures affecting your overall success rate.

Unfortunately, there's no magic number that tells us when the additional
return is no longer worth the risk. So, ultimately, we have to learn where
that cutoff lies for us as individuals in order to maximize returns for the
amount of risk that we're willing to take.

However, in investing it is often possible to dramatically increase our
returns while reducing our risk by seeking companies that possess certain
characteristics. And, to that end, it turns out that whether a company pays
a dividend is a rather important characteristic.

The real deal

Do you need proof in order to believe that you can actually receive greater
returns while taking on less risk just by investing in dividend-paying
stocks? Well, BusinessWeek has pointed out that the return of the Nasdaq
stock market, known for its healthy dose of aggressive technology stocks,
actually underperformed the S&P Utility Stock Index from 1971 through the
third quarter of 2001 -- 11.2% vs. 12%, including dividends.

Granted, the actual difference in return is modest, but the real importance
here lies in the fact that the utility investors took on substantially less
to achieve their return, making the difference on a risk-adjusted basis
much more meaningful.

Indeed, the utility index beat the Nasdaq while incurring about half its
volatility. The bottom line: During this period, Nasdaq investors were not
adequately compensated for the amount of risk they took on, so don't take
unnecessary risks in your portfolio. In the end, one could have achieved a
higher total return, experienced far less price fluctuation, and maintained
substantially higher level of income by owning the boring, old utility

Several other studies bear out what we've seen here. Dividends have
contributed 42% of the S&P 500's total return since 1926. That's right --
when it comes to that 10.2% S&P 500 return figure that everyone tosses
around, nearly half of it came from dividends.

The income answer

I'm not saying that every stock in your portfolio has to be a utility or a
dividend stock -- far from it. However, investors must always be conscious
of the level of risk that they're taking to achieve their reward, and
historically speaking, dividend-paying investments have offered the most
compelling risk-reward trade-off available. Opportunities to achieve above-
average returns while taking below-average risk abound in this investment

For instance, the best-performing investment selection for Motley Fool
Income Investor has been Annaly Mortgage (NYSE: NLY). This company
has returned 19.14% to our readers over the past six months, handily
beating the 5.3% of its benchmark. Despite its increase, the firm still
boasts a yield approaching 11%. The real story here, however, is that the
company has produced its market-beating return while being only one-third
as volatile as the overall market. So, again, on a risk-adjusted basis the
return is much more favorable.

The same can be said for all of the newsletter selections thus far, as well
as the stocks selected for the income-producing Six-Pack Portfolio on back in March of last year. Overall, Income Investor selections
are doing 10.4% better than the market while being only 10% as volatile as
their benchmarks.

The Six-Pack Portfolio, including investments such as BellSouth (NYSE:
BLS), ConAgra Foods (NYSE: CAG), and Altria (NYSE: MO), has
produced a total return of 45.5%, comfortably beating the S&P's 35.22%,
and again, the Six-Pack has been just half as volatile as the overall
market. I continue to favor this portfolio, and believe these companies will
march higher in the years to come while producing substantial dividends
for income-oriented investors.

Another important aspect of the income-investing strategy is that dividend
payers tend to fall only half as much as non-payers in down markets, as
they have their yield to help support the shares. There are a great many
people who were wishing they had a few dividend payers in their portfolios
when the bears came calling. If you and your stomach endured the wild
rides of a Cisco Systems (Nasdaq: CSCO) or an (Nasdaq:
AMZN) in the late 1990s, think about how much money you'll save on
Maalox consumption once you're in solid, dividend-paying companies.

The Foolish bottom line

Identifying one's risk tolerance is a difficult process. Can I truly stomach
the volatility of my investments? Am I OK with the idea that I could
lose money? Can I survive that Mariah Carey concert? But the good news
is that there's an entire investment approach that can keep you in the
shallow end of the risk pool without drowning you in underperformance.
Join the income investors (in fact, right now you can take a free trial) and
fall asleep when your head hits the pillow.


I reproduce this article here because I am gradually shifting my own share
portfolio towards more income producing shares.    Some would see that
as more conservative.  Myself, I see it as more aggressive because I am
moving my investments into shares that over time have performed the best
of all.
The truth is I am probably becoming more conservative and more
aggressive at the same time which kind of flies in the face of any 'risk
return' share investment philosophy.

Of course fundamental to producing a dividend stream is that the
underlying company must be making a profit.    I do find it amazing the
number of people prepared to invest in companies that are not only not
making any money but appear to be teetering on the brink of bankruptcy.
Now I wouldn't deny anyone any speculative fun.  But I wonder how many
of those investors know the risks they are taking?    The counter argument
to this is that the speculative risks are worth taking to get the
rewards.   However, over the long term and using the S&P Utility Index vs
NASDAQ comparison in the article I quoted, it seems that these
speculative rewards do not exist.


discl: do not invest in shares without a profitability track record.

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