Do you know Wall Street’s biggest secret?

Do you know Wall Street’s biggest secret? There are many mutual funds on Wall Street that want to sell you, or they are "absolute return" funds...

Do you know Wall Street’s biggest secret? There are a lot of mutual funds on Wall Street trying to sell you, whether they're "absolute return" funds, or "mid-cap blend" funds, or maybe "small-cap growth" funds. Many brokers, financial advisors, and salespeople will tell you that only by mixing all these funds in the right proportions can you construct a portfolio that perfectly matches your "risk tolerance." What nonsense. Before you invest real money, listen to Bob Haugen's advice. The former finance professor has spent half his life studying the stock market. He is the author of numerous books and papers, and co-authored Case Closed, an extraordinary analysis. In the article, he painstakingly analyzes in detail the characteristics of the best-performing (and worst-performing) stocks over nearly half a century from 1963 to 2007. What did he find? Most so-called "fashion" stocks are not worth investing in. And the idea that you have to take more "risk" to get more returns is a complete lie. Haugen said that the stock market actually has a huge secret. He said that for decades, "the stocks with the highest risk have created the lowest returns, and those stocks with the lowest risk have created the highest returns." In other words, the risk and return of stocks should be inversely proportional... From his study of stock market performance over a 45-year period, the market's return to risk has always been negative. You won't be rewarded for taking the risk yourself, but you will be rewarded for choosing not to take the risk. All those glamorous and sexy "growth" stocks, all that extra volatility you endure in the desperate pursuit of high returns, is not a good thing. If you had invested your money in low-risk "value" stocks that seemed to only allow you to maintain capital and make a small profit, your investment returns would actually be much better. The stocks that win out in the test of time are those that appear cheap when considering factors such as net asset value per share, earnings, cash flow and dividends. The companies issuing these stocks are currently making huge and growing profits, and these stocks do not belong to companies that are betting their happiness solely on the next 10 years. They also often benefit from recent growth momentum in the stock market. While Haugen says it's hard to find "perfect" stocks, you can still find stocks that perform well to build a portfolio. Investing in value stocks can yield good returns. Haugen and Case Closed co-author Nardin Baker wrote: There is strong evidence that simple intuition is more reliable than all those complex theories about expected returns. Simple intuition will actually make it easier for you to make more money. The strategy of investing based on your gut can work even after accounting for transaction costs. This finding isn't exclusive to the United States, either. Haugen also looked at historical data on UK, French, German and Japanese stock markets. The result is the same. Stocks with lower volatility deliver higher returns. It's literally a free lunch. Many professional investors already know this, but too many don’t. And among those who know it, many people keep forgetting it and rush to pursue those expensive "potential stocks" again and again. That's been the case recently. Nor will Wall Street disseminate this valuable information to the public too broadly. It is difficult to explain to customers. And if clients knew there was an easy way to get higher returns with lower risk, why would they need a fund manager? Haugen is not alone in making this analysis. Contrarian investors have highlighted data for years showing that "value" stocks consistently outperform "growth" stocks over any extended period of time. James Montier, a well-known strategist at the investment company GMO, once proved that Japan's great bear market in the past 20 years was entirely due to the decline of "charm" stocks. He found that if you held Japanese value stocks during this period and shorted these glamor stocks, you actually made money. This free lunch proves that the market is far from completely "efficient." This fact, Haugen says, is a fatal blow to the efficient market hypothesis. Even some ardent believers in the efficient market hypothesis are forced to partially admit this view. They have maintained for decades that to get higher returns, you have to accept more volatility, or "risk." When they looked back at the data, they realized that wasn't necessarily the case. They acknowledge that smaller companies perform better than larger companies and that value stocks perform better than growth stocks -- even though they involve less risk. Oh, so it works like this. What does this mean to you today? As it happens, growth stocks have seen big gains during the stock market rebound over the past two years. So investors once again allowed themselves to fantasize about future glory instead of focusing on today's profits. According to FactSet data, since the beginning of 2009, growth stocks have performed 20% better than value stocks. It's unbelievable. Small-cap growth stocks performed best. Large-cap value stocks, the safest of all stocks, fared the worst. If history is any guide, this phenomenon will be temporary and an opportunity for smart long-term investors. The obvious conclusion is that now is the time to sell growth stocks and buy value stocks or value funds. While I'm cautious about the overall stock market at current levels, if I were buying stocks, I would buy a low-valuation large-cap value stock fund.