Risk and Return - simplified and complexified

Aug 24, 2021 | Jeremy Goldfarb


Yes....I made up that word. At least I think I did, but if there is one theme that seems to be dominant these days, it is word invention. 


When we look at the speed of the economic and market recovery since the depths of March 2020, the figures are somewhat eye-watering. When you put everything into context however, they start to make more sense, however that is not what I am heading towards today. I want to discuss risk and return, and how it is perceived. More importantly, how it is perceived when taking into account recency bias. 


A conventional chart shows that the prospect of return increases with incremental additions of amounts of risk. This is quite true. 


It is also true that the investing public is increasingly comfortable with risk, when markets are running bulls. 


What is important to remember is exhibited in the chart below: While returns prospects go up for each additional unit of risk undertaken, the spectrum of outcomes also grows exponentially. Have a look at the chart and let's talk about it. 



*Chart courtesy of Matt Carthy: RBC GAM