Life & Investing: The Delicate Relationship Between Risk and Reward

When it comes to investing your money there are a lot of options that you should know about. There are stocks, bonds, mutual funds, ETFs, options, futures, certificates of deposit, high interest savings accounts and more. Even within these categories there are different investing styles - day trading, swing trading, short term investing, long term, technical analysis and value investing to name a few. All of these investment variations have unique benefits that go along with their own downfalls which we will get into later. For now I want to discuss the direct relationship between risk and reward.

The more I think about it, the more I realize that there is an R/R relationship for everything in life. I would say that in most cases the higher the risk, the greater the potential reward or loss. I recently saw a video that absolutely blew my mind. I’m sure you’re familiar with base jumping, the sport of jumping off of tall buildings, bridges and cliffs to free fall for a very few seconds and pull a parachute just a few hundred feet away from the ground. For a while I thought that this was one of the most dangerous extreme sports around. But let’s think of the R/R side of things. On the positive side, you are doing what most humans can never do. Jump off of an extremely high landmark, fall to what would normally be your death and at the last second pull your parachute and land safely on the ground. What a rush! On the other side of things, if your parachute does not open fully you will probably break near every bone in your body if you survive. If it doesn’t open at all there’s really only one result, which I’m sure you can figure out. So what do base jumpers do when they get bored? They fly.

The relationship between extreme sports and investing is relatively similar; it's only the asset that you risk losing that differs. Because of the high risk, you can lose a lot of money or make a lot of money. In extreme sports, you can either have the rush of your life or get severely injured. I would compare this lifestyle to investing in micro caps, options, futures, day trading and other short term trading strategies in general. There are definitely ways to minimize your losses but they can still be large.

Now on the more conservative side of things, what if you were to never leave your house? Assume you had an unlimited supply of food and never had to leave your house. I can only imagine that kind of lifestyle would be one of the less risky ones. No possibility of car crashes, shark bites, catching the flu from someone. A very safe and virtually risk free life. But would that lifestyle be very rewarding? Not for me, that’s for sure. This kind of lifestyle can be compared to investing in Certificates of Deposits, Bonds, Money Markets, FDIC savings accounts and other such investments. There is a greatly reduced percentage of return because of greatly reduced risk.

There are exceptions to every rule but in general the higher the risk, the greater the reward whether it’s a gain or loss.