Evidence from practicing investors and academics alike points to an undeniable conclusion: Returns come from risk. Gain is rarely accomplished without taking a chance, but not all risks carry a reliable reward. Financial science over the last 50 years has brought us to a powerful understanding of the risks that are worth taking and the risks that are not.
Everything we have learned about expected returns in the equity markets and fixed income markets can be summarized by two sets of factors. The equity market factors are as follows:
Market - - stocks have higher expected returns than Fixed Income
Size - small company stocks have higher expected returns than large company stocks
Price - - lower-priced "value" stocks have higher expected returns than higher-priced "growth" stocks.
While the equity markets have three factors, the fixed income markets only have two. The two factors are as follows:
Maturity - longer-term instruments are riskier than shorter-term instruments
Default - Instruments of lower credit quality are riskier than instruments of higher credit quality |
