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Returns comes from Risks |
Avoiding risk is human nature, so it’s understandable that many people hope to earn relatively stable investment returns under low-risk or even risk-free conditions. However, low risk usually comes with low returns. Sticking to such a conservative investment strategy over the long term may seem to reduce volatility on the surface, but it inevitably exposes one to the “risk of low returns” and the gradual erosion of wealth by inflation.
Let’s consider two possible investment strategies:
Strategy 1: Starting at age 25, invest ¥10,000 per year entirely in a passive index fund such as the S&P 500, assuming an annualized return of 8%, and continue for 50 years.
Strategy 2: Starting at age 25, tighten your budget and invest ¥20,000 per year (twice as much as Strategy 1) entirely in relatively low-risk government bond and high-grade corporate bond funds, assuming an annualized return of 4%, also for 50 years.
Which strategy do you think will result in a higher net investment value by age 75?
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The green line is strategy 1 and the blue line is strategy 2 |
The green line represents Strategy 1, and the blue line represents Strategy 2.
The answer may be surprising: after 50 years, the net investment value of Strategy 1 is about ¥5.73 million, while Strategy 2 yields only ¥3.05 million. Although Strategy 2 invests twice as much money, its final outcome is only about half of Strategy 1’s. This clearly shows that, in long-term investing, excessive risk aversion is itself a major risk—it can cause you to miss the opportunity to achieve your financial goals.
More importantly, the above calculation doesn’t even take inflation into account. If the annual inflation rate is 2%, the real annualized return for Strategy 1 drops to about 6%, while that of Strategy 2 falls to only 2%. In this case, the gap in real purchasing power between the two strategies becomes even larger.
Unfortunately, in real life, many people ultimately choose the conservative path of Strategy 2—and miss the chance to truly experience the power of long-term compounding.
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