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returns when investors accept the additional concentrated and unsystematic risk of individual stocks relative to their designated index. The additional risk of buying individual stocks does not increase expected returns.

The Trade-Off Between Risk And Return Even when all non-compensated risk has been eliminated from a portfolio, an investor cannot escape the systematic risks inherent in the market itself. As previously mentioned, history shows an investment in the U.S. market as a whole has delivered about 9.6% a year on average for the last 86 years, but not without substantial uncertainty. Risk and return go hand in hand. To obtain greater stock returns, the trade-off is suffering significant short-term volatility, such as that investors experience first-hand every day, with about 49% of daily returns being negative.

The Dimensions Of Investment Returns

Sharpe’s CAPM was widely held as the explanation of equity returns until 1992 when Nobel Laureate Eugene Fama and Kenneth French introduced their Fama/French Three-Factor Model, identifying market, size and value as the three factors that explain as much as 96% of the returns of diversified stock portfolios. Fama and French analyzed the CRSP database back to 1962 to determine that equity returns can be explained by a portfolio’s exposure to the market as a whole, as well as the exposure to small and value companies. Their data show that small and value companies carried higher risk and that risk was rewarded. These small and value excess returns had shown to carry long-

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