RebelCapitalist: Financial Information for the Rest of Us

High Return = High Risk

Feb 18, 2009 | By: Mr_Blue | Comments | Permalink | Tags: risk, returns, investment yields

This is a very basic investment principle. It doesn’t matter if it is the stock market, real estate or a investment schemes. I raise this issue in part because of the billion dollar scams run by Bernie Madoff and Allen Stanford that are currently in the news. It seems that people who invested with these two scam artists were promised high investment returns but what they may have failed to realize is that with the high investment returns comes high risk.

The theory is that people/investors want to be compensated for the increased risk they are assuming. This principle of High Return = High Risk is very important when comparing investments. For example, U.S. Treasury Securities are considered very conservative investments - little risk. The yield on a 30 year Treasury Bond is 3.46% compared to an investment grade corporate bonds which have an average yield of 6.48%. This quick comparison says that investment grade corporate bonds are more risky than U.S. Treasury Bonds.

Time is also a factor in the principal of High Return = High Risk. Investments that have longer maturities tend to have higher yields or higher returns. The reason is that our money is at risk with longer time horizons than shorter ones. That is one reason a Money Market Account, which typically invests in short-term, highly liquid (easy to sell) securities, earns a low rate of return compared to a mutual fund that invests in long-term corporate bonds. A longer time horizon means more risk; and more risk means a higher return.

So, if anyone tells you that they can guarantee you a high investment return with very little risk - watch out - because they are nothing more than a Snake Oil Salesman.