The protégé to Milton Friedman and great economist Thomas Sowell is a personal hero of mine. One of his books Economic Facts and Fallacies is the inspiration for a series of posts I will be writing on this blog titled Myths & Fallacies. My posts will be economically related, but will focus specifically on investing, financial planning, and capital markets as always.

Too often folks equate stocks with risk. This is a fallacy. The idea that more stocks equals more risk or that less stocks equals less risk is a myth. It is true that stocks are much more volatile than bonds over short-term periods. Volatility or short-term unpredictability should not be used interchangeably with risk.

Risk is the potential of gaining or losing something of value. Stocks and bonds both have the potential to lose value. Stocks have a much higher probability of losing value from day-to-day or even year-to-year than bonds have, and too often that leads folks to say things like “bonds are safer than stocks.”

Is that really true though, are bonds safer than stocks? If your definition of safe is a higher probability of lower long-term returns with less short-term volatility, then yes, bonds are safer.

That is not my definition of safe, and hopefully it is not your definition either. I think the safest investment is the one with the highest probabilities of success. There are no certainties when investing, only probabilities.

Think about this, over 20-year rolling periods stocks have outperformed bonds 97% of the time, and have an average a cumulative return of 908% vs. a cumulative return of 247% for bonds. Over 10-year rolling periods stocks have outperformed bonds 82% of the time and have a cumulative average return of 209% vs. 80% for bonds.

If you had two different options for placing a bet, and one had significantly higher probabilities of winning with a better payout; wouldn’t you do that one? Of course you would.

Many investors mistakenly invest too heavily in bonds, and not enough in stocks. They do this, because they think they are doing the safe and conservative thing.

The reality is that feeling safe and investing too conservatively, is often the riskiest thing an investor can do.

More stocks DO NOT equal more risk in a portfolio. The “risk” of the portfolio should be defined by its likelihood of meeting the objectives of the investor. Given the time horizon and goals of the investor there are many instances where adding more stocks to the portfolio will increase the probabilities of success and therefore actually reduce the “risk.”