Introduction to Risk and Reward
Risk versus reward—it’s perhaps the toughest challenge in all of investing. Wouldn’t it be great if the least risky investments were also the ones with the highest return? Unfortunately, the world doesn’t work that way. Assets that are considered safer usually pay lower returns, and those that are riskier may pay higher returns. Why? Because potential reward is the enticement for taking on higher risk.
Understanding the Risk vs. Reward Trade-off
Generally, investors tend to be risk averse. Their goal is to achieve the highest possible expected return while carrying an acceptable risk. When the markets are rising and everyone’s eager to own those glamor stocks, the chances of achieving this objective may be higher. But the markets don’t always rise. And sometimes, when they fall, they fall quickly and violently. Financial markets can be vulnerable. Any sign of fear—inflation, geopolitical tensions, an economic downturn—can create uncertainty for investors and lead them to sell off their investments.
Stocks and Bonds: A Comparison
Historically, stocks have had higher returns than bonds over the long term. Since the Great Recession (2007–09), average annual returns from U.S. stocks were 10.29% (as of 2025). Average annual returns from treasury bonds were 4.26%. That’s a solid baseline to measure potential returns. From there, you can drill down into the specifics of any individual investment. In the case of stocks, that would be company earnings and other fundamental metrics. For bonds and other fixed-income investments, it would be the current yield.
Measuring Risk: VIX and Beta
There are two different ways to look at stock market risk: how much risk is expected in the overall market, and how much risk is expected in a specific stock or exchange-traded fund (ETF) relative to the overall market. The Cboe Volatility Index (VIX) indicates the amount of volatility expected in the S&P 500 over the next 30 days. When markets are extremely volatile—particularly to the downside—the VIX tends to spike, which is why it’s often called the market’s “fear gauge.” A high VIX can make investors uncomfortable and lead them to sell their investments.
Single Investment Risk: Beta
Beta looks at the correlation of an asset with a market benchmark such as the S&P 500. High-beta stocks are considered more volatile than the broader market, and low-beta stocks are less volatile. Stocks that move more than the market are described as having high beta, whereas stocks that are less volatile than the market are considered low-beta stocks. You can find out a stock’s beta from most services that provide financial quotes.
Bond Risk
In general, bonds and other fixed-income investments are considered “lower risk” than stocks, but there are still risks associated with fixed-income investing. Beyond the bond’s price risk—bond prices fluctuate daily, just like stocks—there’s another big risk specific to bonds: default risk, which is the risk that the issuer might be unable to meet its obligations. Bond ratings indicate the risk you’d be facing if you were to own the debt of the bond issuer. The three big bond rating agencies—Moody’s, S&P Global Ratings, and Fitch Ratings—follow a similar hierarchy when rating bonds.
Key Points to Remember
- Risk and reward go hand in hand, so it’s essential to find that investing sweet spot.
- The Cboe Volatility Index (VIX) is one way to measure the current risk in the overall market.
- Beta measures individual stock (or ETF) risk against a benchmark such as the S&P 500.
- Moody’s, Fitch, and S&P are among the firms that issue bond ratings.
Conclusion
Analyzing investments from a risk-versus-reward perspective can help you decide if they’re right for you. But risk isn’t static. It changes when market dynamics change, which is why you should monitor volatility and beta for equity investments, and bond ratings for fixed-income investments. They give you a general idea of the risk levels. Remember, each investment you’re considering has its own unique set of risks. Plus, risk is only half of the risk/reward equation. There’s another array of metrics—called fundamental analysis—to help you analyze the “reward” part. By understanding both risk and reward, you can make more informed investment decisions that align with your goals and tolerance for risk.
