RebelCapitalist: Financial Information for the Rest of Us

Risk Vs. Return

Jun 30, 2009 | By: Mr_Blue | Tags: investing, risk

That is investment return or the gains and/or income we earn on our investment. The relationship of risk vs. return is a fundamental one in finance and investing. It is a relationship that we must not forget when investing our hard earned money.

The relationship between risk and return is very direct and positive one. It goes: higher the risk - higher the expected investment return. The opposite is also very true: lower the risk - lower the expected investment return.

This boils down to compensation. Investors need to be compensated for taking on higher risk. For example, a stock mutual fund, which is risky because of the volatile nature of the stock market, will have a much higher return than say a U.S. Treasury Security (such as the 10-yr Treasury Note) which are considered very low risk (some Treasury Securities are considered “risk-free”).

Next time you hear some salesperson say that they can “guarantee” you a high rate of return with very little risk - don’t believe them. First, there are no “guarantees” when it comes to investing. Second, remember high return equals high risk. Not too long ago there was an swindler who was pushing high return/yielding Certificates of Deposit (CDs) - 7%-8%. By today’s standards, that is incredibly high for a CD. People invested in these high return CDs but the swindler failed to disclose to the investors that he was using the money to invest in very risky investments. In the end, the swindler’s investors lost billions of dollars because they were fooled into thinking they could get a high return with very little risk. It’s just not possible.

This relationship between risk and return is very important when we are deciding how to invest our money particularly in mutual funds. Just remember:

High Risk = High Return

Good luck.