How to Average 4% a Year Risk Free?

MarkCarnage

Averaging 4% risk free is not a feasible option at present. And that's before we get onto the debate about what constitutes 'risk free'. Free of which risks?

masonic

MarkCarnage wrote: »

To claim that passive is the 'least risky' form of investment is very misleading. Market risk, which is what you get when going passive tends to overwhelm active risk (from stockpicking) in most cases.

That's an interesting thesis, but one I've not seen any data to support. Care to elaborate?

chockydavid1983

Trying to average 4% a year is a pretty arbitrary target.
A better target would be to average inflation + x%.
The only way to guarantee return every year is in cash accounts, the best of which are regular savers on small amounts, which beat inflation. Other than that, you'll be losing to inflation in other cash accounts but there is still a place for cash accounts for the purposes of an emergency fund.
To average good returns long term, you need to be investing which, while it has the probability of losing money in the short term, the probability of good returns increases the longer you stay invested.

MarkCarnage

My main contention is that to state that passive investment is least risky is at best misleading.

For a start, what context is the statement made in, and with what reference to risk is it 'least risky'?

I will simplify by assuming that the comment is made in the context of equity investment.

Market risk, or beta, is the overwhelming component of total risk. Investing passively gives you a beta of 1 - you get what the market does, whatever that market is. If it falls 40% in 6 months (think 2008-9) that's what you get. The universe of actively managed funds will be distributed above and below that, mostly in quite a narrow range, but there are managers who seek to run portfolios with low beta, or constrained volatility which may deliver quite a bit better than -40%. They may not participate fully in line with the eventual upturn, but they are lower risk funds in the definition of risk = volatility of return.

I have also used managers in institutional (pension fund) space who have delivered above average performance with below average risk over quite lengthy time periods. There will come a time when they don't, but that's a different debate.

If you define least risky as predictability of outcome relative to benchmark, then passive wins, but that's not low risk in absolute terms.

I have a big conceptual problem with anyone saying passive = low risk.

masonic

MarkCarnage wrote: »

My main contention is that to state that passive investment is least risky is at best misleading.

I have a big conceptual problem with anyone saying passive = low risk.

I don't have any issue with those statements. Market risk, in most equities markets, is appropriately described as high. But I don't think that active management delivers lower than market risk "in most cases", though clearly it does in some. Those funds that do seek lower than market risk, are generally satisfied with lower than market performance in a rising market, whereas a large number of funds take on greater than market risk in order to deliver something close to the market return.

Prism

masonic wrote: »

Those funds that do seek lower than market risk, are generally satisfied with lower than market performance in a rising market, whereas a large number of funds take on greater than market risk in order to deliver something close to the market return.

There is an interesting alternate theory to higher risk = higher returns that has been done and is used with both active (e.g Fundsmith) and passive (e.g iShares Edge min vol) - simply lower risk stocks can lead to higher returns. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2055431

Linton

Prism wrote: »

There is an interesting alternate theory to higher risk = higher returns that has been done and is used with both active (e.g Fundsmith) and passive (e.g iShares Edge min vol) - simply lower risk stocks can lead to higher returns. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2055431

This sounds like the theory behind the High Yield Portfolio idea of 20 years ago and Woodford's successes with Invesco. With the increasingly long wait for the next serious crash people forget the lessons of the past or are too young to have had the opportunity for the education.

MarkCarnage

Prism wrote: »

There is an interesting alternate theory to higher risk = higher returns that has been done and is used with both active (e.g Fundsmith) and passive (e.g iShares Edge min vol) - simply lower risk stocks can lead to higher returns. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2055431

I hadn't seen this paper before,but there is another one which links the low vol anomaly to option pricing theory.

MarkCarnage

Linton wrote: »

This sounds like the theory behind the High Yield Portfolio idea of 20 years ago and Woodford's successes with Invesco. With the increasingly long wait for the next serious crash people forget the lessons of the past or are too young to have had the opportunity for the education.

It's not like that. High yield was really a form of value investing, but relied on some inflation in the system to bail out duff companies with duff balance sheets.

Linton

MarkCarnage wrote: »

It's not like that. High yield was really a form of value investing, but relied on some inflation in the system to bail out duff companies with duff balance sheets.

Yes but value/high yield is a reasonably good proxy for low volatility. The idea was that this would provide a better long term return than investing in potentially high growth stock which tends to be be more volatile.