Bet On Sure Things

Both investments have an 8 percent average annual return. But Investment #1 has a wide range of returns, while Investment #2 has a stream of returns that more tightly hug the average annual return.

If each of the points on the charts represents a monthly return and both investments achieve the same end result, which investment should you choose?

The answer: Investment #2 — the one with the tighter distribution of returns since it gives you a higher probability of achieving a higher return.

Here’s why: Your investment’s performance will largely depend on when you enter and when you exit. If you enter or exit at any given point along the path of Investment #2, the likelihood of success is greater than it would have been with Investment #1.

So unless you think you can pick the exact bottom to enter and the exact top to exit, you’re far better off finding investments that have a tighter distribution of returns.

Consider the tables here.The long term annual standard deviation tells you that in roughly 70% of the times you get results within +/-SD of the long term average returns.

If you use standard deviation as a gauge of risk, you’ll find that the broad stock market pays you only 1 unit of return for about 2.5 units of risk taken.Hence a buy and hold strategy in the broader stock market index just doesn’t compensate you for risk. It’s a bad investment.So think twice about SIPs into ETFs and Index funds,even if the returns offered look interesting compared to other retail investments.

Many fortunes have been made in the stock market.But these billionaires didn’t make their money by gambling with the odds against them.Most of them are able to influence the odds in their favour by influencing management.See how Rakesh Jhunjhunwala exits from his poor decisions and think if you can do the same.