Risk and Return in Practice
How do risk and return work in practice?
In brief
Higher expected returns come with bigger swings and the possibility of large losses. Time, diversification and your own behaviour decide whether you capture the return.
Key ideas
Losses are lopsided
A 50% fall needs a 100% gain to recover, so avoiding large losses matters more than chasing large gains.
Make an insight card →Diversification is the free lunch
Spreading across many holdings reduces the chance that one failure hurts badly.
Make an insight card →Behaviour is the risk
Selling in a fall locks in the loss; a plan for falls is part of the investment.
Make an insight card →Try it
Losses and recovery
Percentages are not symmetrical. After a fall, the gain needed to get back is larger than the fall, which is why avoiding big losses matters more than chasing big gains.
Open the full page: formula, variables, worked example and cautions →
Also relevant: Compounding & time
Red flag
Returns presented without any mention of the bad years.
Ask before you sign
- What was the worst fall this has had, and how long did recovery take?
- What do I do if it falls 30%?
Do this week
Write your plan for a 30% fall in your portfolio.
Try it · 10–45 minutes
Look up the worst historical fall of a fund you hold and calculate the gain needed to recover.
See it in a life
Cases that bring this chapter to life
Connected ideas
Where else this shows up
Pause and reflect
Private to this device. Nothing is sent anywhere.
Words worth knowing
- Volatility
- How much an investment’s value swings. A measure of bumpiness, not of permanent loss.
- Diversification
- Spreading money across many holdings so that no single failure can badly damage the whole.
- Real return
- An investment’s return after subtracting inflation: what it adds to buying power.
- Sequence risk
- The danger that poor returns arrive early in retirement, when you are withdrawing money, doing lasting damage.
- Risk
- The possibility that outcomes differ from what you expect, including losing money. Not the same as volatility.
Companion notes written for this website, based on the topics of Chapter 20. They explain ideas and do not reproduce the book. General information, not personal advice.