High Risk – High Reward

There is a strong correlation between Risk & Reward. We all know lesser the risk, lesser the return, and higher the risk, higher the return. But what about the highest risk? Does taking the highest risk get converted into the highest return? The answer is clearly 'NO'. 

Had the highest return guaranteed, there would not have been any risk associated with it. On the contrary, returns get diminished if we increase the risk beyond a certain point. The probability of getting the highest returns to drop significantly with the highest risk.

Let's understand with an example. You plan to travel from Mumbai to Pune in your SUV. It generally takes 2 hours to cover 160 kms distance at an average speed of 80 km/hrs. If you increase the speed to 100 km/hrs, it would take 1:30 hrs and if you reduce the speed to 60 km/hrs, it would take 2:30 hrs to reach the destination. Now, what if you increase the speed to 160 km/hrs? Would it take 1 hour to reach Pune? Theoretically yes, but practically its all depend on a lot many other factors as well. The condition of the road, traffic on the road, condition & power of your vehicle, your driving style, expertise, and your ability to have synchronization between gear, clutch, brake & steering at such high speed. Therefore, beyond a certain point, even if you increase the speed, your time will not get reduced rather your risk would get increased drastically.

Our Investments also undergo the same logic. Many investors don’t take long term call for their investments. Many don’t start early and keep on procrastinating their investments till the eleventh hour. Later they think all lost time can be covered by riding on the highest return instrument. That is the reason people chase the return and invest in the scheme which has already given the highest return in the last 6 months / 1 year, thinking that this is the best-performing scheme. They fall into an illusion that the same past performance would also get repeated in the future as well.      

One should understand that lost time can never ever be restored by taking exposure in the highest return scheme or increase in the investment amount. Time is ultimately the most important factor to be considered while taking investment calls and not the return or amount of money being invested. Always recall the compounding formula – Time (exponential power) precedes over Principal deployed (multiplication) and Rate (summation).

Moral: Never ever chase the highest return instruments!