Re-understanding Risk-Reward

One of the basic concepts as an investor you need to get to grips with is that of the intimate, direct, and progressive relationship between an investment's level of return and its inherent level of risk: the more profitable an investment is, the riskier it inevitably is when compared to another investment with a lower level of return.

This concept is so important that it is worth trying to understand rather than memorizing.

Why does a higher return mean a higher risk? Why is there a symmetrical relationship between risk and return? Are there asymmetrical relationships between risk and return?

Let's first explain what a symmetrical return is:

There is a correlation in the stock market that for every percentage of return, there is a percentage of risk. Risk is measured by the volatility of a price versus the average. Simplified: if a price oscillates between $80 and $120, you have an average of $100 with a volatility of $20. Over the last ten years, the stock market has had an average return of 11.98% per year with a volatility of 12.26%. In other words, symmetrical, high returns: high volatility. By comparison, bonds simultaneously had a 3.75% return with 3.54% volatility: symmetrically low returns and low volatility.

It is a piece of "general" knowledge or an urban myth that this trend always exists and is a law.

However, this is not always the case.?

There are many examples where the duality of risk and return is asymmetric.

The venture capital model is asymmetric. For example, if you invest $100 in a start-up and your projected profit is 20%, and the residual value of your investment is $0, you have a risk of 100% vs. 20%. That is a risk-return ratio of 1 to 0.2.?

Another example is at times when markets are not efficient. When the asset's price is lower than its value, your risk profile remains the same, but the return is much higher. For example, at the beginning of the pandemic, all publicly traded companies fell by an average of 20%. It was a time of great distress for humanity but a great opportunity to buy a "cheap" stock relative to its cash flow potential and real price. Waiting for catastrophic events (which occur every 3–7 years) to occur before investing is called being an opportunistic investor or financial vulture. While this is an asymmetric return option and I am not opposed to taking advantage of clear market opportunities, my investment strategy does not bet on something happening overnight, and worse, on taking advantage of adverse global circumstances; my conscience would not be clear.

There is another option, much more reliable, more traditional, and also proven: it is to invest in institutional quality real estate in the U.S. These investment opportunities are, as Tony Robins says in his book "Money: Master the Game," how 1% of 1% of the world invests: "asymmetric risk/reward ratio," that is, opportunities where the gain is much greater than the risk.?

Let's risk a little and gain a lot.

Continuing our example, large-scale real estate in the U.S. had an average return of 10.17% with a volatility of 2.98%. This means we have asymmetric returns versus risk, and these numbers are only the average.?

At the professional level, we look for ways to make our product, market, advanced financial models, teams, etc., more competitive. At Infinity9 Investment Group , we measure 162 different variables, use professional expertise, and have trusted relationships with strategically placed people that give us competitive advantages to ensure that we have not only low risk, but in the worst-case scenario, we still have a great business on our hands and deliver for our clients.

So, let's break the "memory" that you have to incur great risk to have a great return. Not all investment vehicles are the same, and as next-level investors, we need to look for those opportunities that take a little risk and make big returns.?

Sources:

Bonds: represented by the Bloomberg Barclays U.S. Aggregate Bond Index, a broad-based flagship benchmark that measures the investment-grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasury, government-related, and corporate securities; MBS (agency fixed-rate and hybrid ARM pass-throughs); ABS; and CMBS (agency and non-agency).

Public REITs: represented by the National Associate of Real Estate Investment Trusts (NAREIT) All REITs index, a market capitalization-weighted index that includes all tax-qualified real estate investment trusts (REITs) that are listed on the New York Stock Exchange, the American Stock Exchange, or the NASDAQ National Market List.

Private real estate is represented by the National Council of Real Estate Investment Fiduciaries (NCREIF) and the National Property Index (NPI). This index goes all the way back to 1978 and has over 8,300 properties with a market value of over $658 billion. Its objective is to provide a historical measurement of property-level returns to increase the understanding of and lend credibility to real estate as an institutional investment asset class.

Stocks: represented by the S&P 500, an index of 500 stocks chosen for market size, liquidity, and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe (Investopedia).