The Misconception: High Risk Does Not Mean High Return

In the world of investing, the phrase “high risk, high return” has been widely misunderstood. Many believe that high-risk investments will automatically yield high returns, but this is far from the truth. If high risk always guaranteed high returns, it would no longer be classified as risky. Instead, it’s essential to recognize that while high-risk investments may have the potential for high returns, there is also an equally significant potential for loss

Understanding the Risk-Return Tradeoff

The concept of the risk-return tradeoff is fundamental to investing. It suggests that to achieve higher potential returns, you must be willing to accept a greater chance of loss. However, this does not mean that every high-risk investment will provide a high return. The relationship between risk and return is more about probabilities than guarantees.

For example, venture capital investments are considered high risk. While some startups may grow exponentially and deliver massive returns, many others fail, resulting in a complete loss of capital. Therefore, high risk implies high uncertainty—not necessarily high return.

What Is “Expected” Return?

Investors often confuse “expected return” with guaranteed return. Expected return refers to the average return an investment is likely to generate over time, accounting for both gains and losses. With high-risk investments, the expected return may be higher compared to low-risk investments, but there is still a wide range of possible outcomes.

For instance, an investment with a 50% chance of doubling your money and a 50% chance of losing it all may have a high expected return, but that doesn’t guarantee success. This probability of significant variance is what makes it high risk, not the certainty of high return.

The Role of Probability in High-Risk Investments

Investing in high-risk assets involves weighing probabilities. When people hear “high risk,” they often ignore the fact that they are also taking on a significant chance of failure. They focus only on the potential high reward, leading to skewed expectations.

The reality is that most high-risk investments may not achieve high returns. The higher the risk, the more volatile the potential outcomes, meaning losses are just as likely as gains. The probability of high return may be low, but the potential for catastrophic loss is ever-present.

If High Return Were Certain, It Wouldn’t Be High Risk