Ed Mamula.com

Getting To Enough asks, How Did You Really Do Last Year?

The article wisely reminds investors to compare their returns to their relevant benchmarks instead of focusing on an arbitrary benchmark like 10%.  The only point not covered by the article is how much volatility (Beta) did you endure in order to get to the absolute rate of return.  Many people claim that all they care about is the bottom line rate of return, but they cannot stomach the volatility that occurs in the interim, and they change investment strategies too often, chasing the hot performing sector, reducing their overall rate of return, and becoming frustrated in the process.  An investor can improve his results by mentally rehearsing for “normal” losses, staying the course when appropriate, and searching for investment strategies with the best risk adjusted rate of return for any given volatility level.

In modern portfolio theory, the number that describes risk-adjusted return is called alpha.

Alpha – A coefficient which measures risk-adjusted performance, factoring in the risk due to the specific security, rather than the overall market. A high value for alpha implies that the stock or mutual fund has performed better than would have been expected given its beta (volatility).

 Simply put, investors need to do some self-exploration in order to determine their personal risk tolerance (Beta tolerance), and then search out investment strategies with the least negative volatility that will carry them to their expected rate of return.  All else equal, fewer big swings in the account mean fewer sleepless nights.
 

There is a post on Get Rich Slowly that asks “Are Index Funds the Best Investment?”?
I agree with the commentors that the “best” investments are a function of the individual trader or investor’s objectives and risk tolerances.
 As I understand it, if (and only if) an individual believes the in the Efficient Market Hypothesis, then market cap weighted index funds are the natural choice.
 Since we’re all human, and we’re all different though, we may feel a varying need to actively outsmart the market or to hire managers to try to outsmart it for us.

The first step to success is to begin investing.  We should never let discussions about the “best” way to do something keep us from doing anything at all.

Readers of my site might already know that I am essentially a trend follower, and I do not believe that the market’s movements are random.  I don’t suppose I can prove it, but
while the academics are proving that I can’t “beat the market”, I’ll be here buying high and selling higher.