“Can investors forego short-term thrill for long-term reward?”
In a rational investment market, investors demand higher returns to compensate for higher risk. Therefore, one should logically expect lower returns from safer securities and higher returns from riskier securities. This has long been one of investing’s fundamental precepts. However, rational is not always an accurate description of investor behavior.
If I lose 20% of my money this year, but I’m up 20% next year, I’m back to even, right?”
At first glance, this may seem correct, but it doesn’t accurately reflect the effect of losses on an investment portfolio. Understanding the difference between arithmetic and geometric returns and how they relate to portfolio value is essential to understanding what volatility means to your long-term investment success.