Guest Post

Relationship Between Risk and Return

Relationship Between Risk and Return

When it comes to making decisions for your business, there’s always that fear of failure and a loss of profit. And that fear is very real for startups in particular, as 90% of startup end up failing. But listen to almost any business success story, and you’ll hear the speaker talking about taking some form of risk at some point in their career.

Nowadays, it’s common knowledge that risk and return share a unique bond, but is this bond good or bad for your business? To understand this phenomenon better, we’re going to break down what risk and return are individually, and see how they interact with one another when put together.

Understanding Risk

The term “risk” gets thrown around a lot in business conversations, but what is “risk” exactly? According to Investopedia, business risk is basically the level of exposure to certain real-world elements that can put your business in jeopardy. That means anything with the potential of harming your business can be considered as a risk.

Understanding Return

Just like the term “risk”, “return” is a word mentioned often when talking about business operations. Investopedia defines returns as “the money made or lost on an investment over some period of time”. However, in some cases, “returns” may not necessarily refer to something of monetary value. Any net gains that come from business operations can be considered as a return, depending on how you define the term itself. These can be in the form of:

  • Investments that aren’t cash-based
  • A growing community of customers
  • Partnerships with other businesses

Risk and Return’s Relationship

So we know that, in layman’s terms, “risk” is comprised of anything that can go wrong, whereas “returns” refer to anything that can go right. But how do these polar opposites relate to each other?

Well, if you haven’t figured it out yet, risk and return have a directly proportional relationship with each other. In other words, the greater the risk, the greater the return, and vice versa. You don’t just earn money for free, especially when you’re putting your business on the line. There are ways to have as least risky of an investment as possible, but generally, the rule still applies.

Note that this doesn’t necessarily apply all the time, though. In fact, there are many cases where the returns are nowhere near as great as the risks. As a general rule, though, deals that entail potentially high profits can also bring about a good amount of risk, meaning that you’ll have to weigh your options wisely no matter what deal you plan on taking.

So far we’ve only delved in the theoretical aspects of risk and return. Let’s take a look at how these two exhibit their relationship clearly in the real world.

Examples of the Risk/Return Relationship

If there’s one aspect of business that showcases the relationship of risk and return perfectly, it’s the investments market. Anyone who’s had experience investing and trading financial assets knows that everything involved in the financial market revolves around this principle.

You see, the different forms of financial assets in the financial market carry different levels of risk.:

  • Government bonds – these have a low-interest rate but are generally the safest financial assets in the market due to the guarantee of the government paying up. You lose out on higher interest rates from other financial assets, but the guaranteed payout makes it worth the investment anyways.
  • Stocks – if one were to purchase stocks of a growing startup, it would be a completely different story. Even if the startup somehow showed promise in their previous reports, there is no real guarantee that the startup won’t go bankrupt at some point and lose your money from your investment. 

However, there are many cases where startups and small/mid-market businesses DO end up making huge profits. This results in investors earning a lot more than they normally would through investing in bonds.

That’s why when dealing with the financial market, or just any business venture in general, it’s important to understand the risks that come with investing in deals with potentially high returns. Likewise, you’ll also need to understand when “playing safe” becomes too safe to the point where you earn too little from your investment.

Conclusion

Risk and return work hand-in-hand in the business world, and knowing what separates a good deal from a bad one can save you from the inevitable bankruptcy of most startup companies. If there’s one thing to take away from this article, it’s that while you can definitely earn more by taking risks every now and then, there’s no guarantee in it, and it all comes down to calculated risks and decisions in the end.

DollarBreak is a team of Personal Finance experts. We set out on a mission, to find the best tips, tools, and resources, publish them in well-crafted informative blog posts and bring you clarity in small, but important everyday life financial decisions. Take a break and learn how to Master Your Money.

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