Risk and Reward are two words that are synonymous in the investment world – you can hardly mention one without the other. Risk and Reward however are two different words and two different concepts. We have been conditioned to believe that the two concepts are 2 sides of a single coin: high risk / high reward etc.
In computer science there is a wonderful concept called separation of concerns. The concept exists because solving or understanding problems is easier to do when you separate ideas into smaller, distinct, ring fenced pieces. Solve the smaller pieces and the larger problem becomes easier to solve and easier to understand.
Basically separating concerns helps to identify those situations where its unhelpful to co-mingle ideas. Sometimes ideas seem like they are glued together when perhaps they’re not. We believe that his is the case with risk and reward – we believe risk and reward should be forever separated, here’s why:
Low returns don’t correlate to a “low risk investment”. If that were the case take what you would consider a high risk / high return investment, give ½ of the return to someone else to make it a lower return, then the risk would be lower – right? Well we all know that’s nonsense but the high return/ high risk, low return / low risk equation is fed to investors at nausea and it’s a total fallacy.
There is no such thing as a catch all – high risk investment or low risk investment as risk is an assessment an individual investor makes about the 6 risks of investing and how they apply to a particular investment. The assessment is a personal one that applies to his/her particular circumstances – risk is in the eye of the beholder.
As an investor you make an assessment on the factors that feed into the 6 risks of investing, and you either accept them or you don’t. It’s as simple as that.
A totally unrelated and different topic is that of rewards. Rewards are inherently driven from the investment activity not the “assessed level of risk”. Risk doesn’t drive returns, the activity does. Returns from activities where the competition is high, such as stock market investing, generally revert to the mean because of the intense competition and the lack of unique perspectives and strategies that one can possibly apply in that environment. There are so many eyeballs scouring the market at any one time the opportunity to repeatedly execute highly profitable transactions becomes statistically lower over time and as more transactions are executed. We are not saying that stocks aren’t a good investment. We are saying however that there are other activities that are potentially more rewarding if you know what you are doing.
Risk and reward should be seen as two sides of two entirely different coins. Don’t believe the risk vs reward fallacy!