This is a Guest Post by AK of Fallible
In this video we talk about the types of returns you’re getting in with your trading/investing strategy. By the end of the video you’ll have a new framework to use to look at your strategy and portfolio construction to help boost your returns.
At their highest level, investment returns can be subdivided into three components: the cash rate, beta, and alpha.
return = cash + beta + alpha
The cash rate is the base interest rate controlled by central banks. Every other asset is priced off this rate, including stocks and bonds.
A majority of the time stocks and bonds return more than the cash rate to incentivize investors to take risk. This makes intuitive sense. Why would someone buy risky assets if they could earn the same return in their checking account?
The returns for stocks and bonds are examples of investment betas. Betas are cheap and easy to obtain, especially in the modern market environment. All you need to do is purchase a cheap index fund and hold.
The harvesting of this risk premium doesn’t require market timing. Nor does it require time and energy. It only requires the mental fortitude to hold through volatility. That’s the real “cost” of market beta. Can you watch your nest egg lose 50% and still hold on? If you can, you’ll realize the beta returns.
Improving on these passive beta returns requires something called alpha. Alpha is the reward for good trading strategy. You capture it by making a series of tactical bets against other market participants.
To learn more, make sure you watch the video above!
And as always, stay Fallible out there investors!