Whether we’re pushing out reps at the gym, putting in long hours at the office, or enduring travel woes en route to vacation, we tell ourselves: The rewards will be well worth the discomfort or inconvenience. No pain, no gain.
Unfortunately, that principle doesn’t hold when it comes to investing in funds. The riskier funds have been, the less rewarding they’ve been to own. More pain, less gain. To illustrate, I tallied up all stock and bond funds’ rolling 12-month standard deviations from April 1, 2001, to March 31, 2026, and used them to rank funds versus their category peers each month as follows:
Then I derived each bucket’s average return over the subsequent month and repeated the process for all other months. Here’s how those buckets performed:
At first glance, you might say score one for the risky funds! Indeed, the most-volatile bucket outperformed the others over this 25-year span. But we also need to consider how volatile each bucket’s returns were over this period.
The riskiest bucket was about one-and-a-half times more volatile than the least risky group. Because that was a far wider margin than the return difference, it meant the most-volatile bucket had the worst risk-adjusted returns (as measured by their Sharpe ratio) and the least-volatile the best.
Buy and Hold (Your Breath)
Would the picture change if we hypothetically assumed an investor bought and held the funds in each bucket over a subsequent time horizon? To assess that, I built an event study that measured each bucket’s returns over subsequent one-, three-, five-, and 10-year horizons and then averaged the results across all those measurements. Here’s how it came out:
If you held the riskiest funds over a short subsequent horizon, you made a slightly higher return than you would have in less-risky funds. But if you held over longer horizons, you did no better and even worse than you would have in less-volatile funds.
Moreover, that analysis only considers return, not volatility. Given that, here’s the same thing but based on the funds’ Sharpe ratios over the various event horizons.
Raising the Dead
Keep in mind these results exclude dead funds and, thus, are survivorship-biased higher. That wouldn’t be an issue if funds died at roughly equal rates, but that’s not the case: More-volatile funds die more often than less-volatile funds, as shown below.
Taken together, the more-volatile funds’ subpar average returns and their higher mortality translated to significantly lower rates of success—which I defined as surviving to the end of a rolling 10-year period and generating a higher Sharpe ratio than the average fund assigned to the same peer group at the beginning—than less-volatile funds, as shown below.
Despite this, the most-volatile funds tend to be costlier than less-volatile funds. Here are stock and bond funds’ average expense ratios by volatility rank.
The X-Factor: You
Here’s the other thing about risky funds: They push our buttons. The more widely returns swing compared with similar funds, the more likely we are to trade inopportunely, buying high and selling low.
You can glimpse this from research we’ve done on the funds that were the biggest losers in dollar terms over the decade ended Dec. 31, 2024. A number of these funds are uber-streaky, and that, paired with dismal performance in the case of some of these funds, appears to have wrong-footed investors to the tune of billions lost.
Bigger picture, when we’ve examined the relationship between funds’ risk and investors’ dollar-weighted returns, we’ve found that the more volatile the fund, the harder time investors have had capturing its total return.
For instance, here is one panel from our annual “Mind the Gap” study in which we compare investors’ estimated dollar-weighted returns with the funds’ aggregate total returns, with funds broken down by their volatility compared with others in the same asset class. In general, investors fared better with less-volatile funds, where the gaps between dollar-weighted and total returns were narrower.
Conclusion
With funds, risk and return aren’t joined at the hip.
True, in absolute terms, you should expect to earn a higher return in stock funds than you would in fixed-income funds over an extended period, and bond funds should beat cash. Why? Equities are more uncertain given their value is a function of their future cash flows, which can be hard to predict, whereas the timing and magnitude of bond interest and principal payments are more foreseeable, among other reasons.
But, in relative terms, when you’re comparing funds within an asset class, and especially within a peer group (as I’ve done in this study), different story. Riskier funds didn’t make enough to compensate for their higher volatility; they died more often, succeeded less often, and cost more than less-risky funds.
Also, because more-volatile funds are likelier to get on our nerves, we may earn less on our average dollar than would be the case if we invested in less-volatile funds, the difference owing to inopportunely timed purchases and sales. That’s not the funds’ fault, but it’s something to keep in mind.
What’s a good way to tell how volatile a fund is compared with others like it? If you go to the Risk tab of a fund’s Morningstar page, you’ll find its Morningstar Risk rating, which is a good shorthand for how it stacks up to peers. You can also find a fund’s Standard Deviation on that tab and compare it with both the average fund and a style-appropriate index. Here’s an example.
Switched On
Here are other things I’m reading, watching, or listening to:
- “Semiliquid Private Equity Funds Have a Math Problem”
- Owen Lamont: “Four Scenarios for the SpaceX IPO”
- Debunking stocks as an inflation hedge
- Big backpack
- Russ Roberts and Tyler Cowen talk AI
- “Heavy metal parking lot” (documentary here)
- Steven Spielberg on what keeps his creative juices flowing
- “Arrival”
- Ella Langley “Low Lights”
Don’t Be a Stranger
I love hearing from you. Have some feedback? An angle for an article? Email me at jeffrey.ptak@morningstar.com. If you’re so inclined, you can also follow me on Twitter/X at @syouth1, and I do some odds-and-ends writing on a Substack called Basis Pointing.