Glossary · Investing and personal finance
Risk and return
Risk and return go together: investments that can pay more over time usually swing more and can lose more along the way.
Also called: risk-return tradeoff, risk premium, equity risk premium
Dividends reinvested. Worst year: −39.2% (2008).
Worst year: −15.0% (2022).
Worst year: 0.0%.
In plain words
Imagine two jobs. One pays $50,000 a year, guaranteed. The other pays $40,000 in a bad year and $80,000 in a good one. Most people would take the second only if it paid more on average; otherwise why live with the uncertainty? Investors think the same way, and that is the link between risk and return.
Cash in Treasury bills or an insured bank account barely moves: it is safe, and it pays little. Bonds swing more and have paid more. Stocks swing the most and, over long periods, have paid the most. The extra return for taking risk is called a risk premium.
Since 1935, US stocks returned 11.3% a year, 10-year Treasury bonds 4.8% and Treasury bills 3.5%. The price of the stock return: terrible years, like −39.2% in 2008.
Example
Why the higher average comes with worse years
- A savings account pays 4% a year: $10,000 becomes $10,816 after two years, every time.
- A stock fund gains 30% in a good year and loses 10% in a bad one, with equal chances.
- One good and one bad year: $10,000 × 1.3 × 0.9 = $11,700. Two good years: $16,900. Two bad years: $8,100.
On average the fund ends well ahead of the account: that is the reward. The chance of ending with $8,100 is the risk.
One level deeper
Investors usually measure risk as volatility: how widely returns swing around their average (the standard deviation). Since 1935, the yearly returns of US stocks had a standard deviation of about 17%, 10-year Treasuries about 8% and Treasury bills about 3%. Other measures look at the worst losses (drawdowns) or the chance of losing money over your holding period.
The reward for risk is an expectation, not a promise. For a decade or more a risky asset can trail a safe one: US stocks returned less than Treasury bills over the 10 years to early 2009. And risk that can be removed by spreading money around (diversification) is usually not rewarded at all: markets pay for the risk that cannot be diversified away.
Return also pays for things other than swings: waiting (the time value of money), the chance of default, inflation, owning something hard to sell. The Sharpe ratio puts risk and return into one number: extra return per unit of swing.
$1 in stocks, bonds and cash since 1934
The more an asset swings, the more it has paid over long periods. Stocks ended far ahead, but their line also has the deepest dips; Treasury bills rose almost without a wobble.
The numbers behind the chart
| Date | Stocks (S&P 500, dividends reinvested) | 10-year Treasury bonds | 3-month Treasury bills |
|---|---|---|---|
| Jan 1934 | $1 | $1 | $1 |
| Dec 1940 | $1.41 | $1.32 | $1.01 |
| Dec 1950 | $4.68 | $1.58 | $1.07 |
| Dec 1960 | $21.18 | $1.95 | $1.33 |
| Dec 1970 | $46.19 | $2.62 | $2.04 |
| Dec 1980 | $103 | $3.77 | $3.99 |
| Dec 1990 | $381 | $13.95 | $9.31 |
| Dec 2000 | $1,924 | $32.3 | $14.87 |
| Dec 2010 | $2,164 | $56.85 | $18.46 |
| Dec 2020 | $7,847 | $86.76 | $19.59 |
| Dec 2022 | $8,556 | $71.06 | $19.93 |
| Dec 2023 | $10.4K | $71.43 | $20.94 |
| Dec 2024 | $13.5K | $72.22 | $22.02 |
| Dec 2025 | $15.6K | $76.92 | $22.95 |
| Oct 2026 | $17.8K | $73.14 | $23.66 |
Why it matters
It is the first question to ask about any investment: what could it pay, and what could it lose on the way?
It explains why “high return, no risk” offers are a warning sign: in real markets the two come together.
It is why savers usually keep money they will need soon in safe places, and accept big swings only with money that can wait.
A common mistake
Myth: Taking more risk means you will earn more.
In fact: It means you might earn more, on average and over long periods. Risk means exactly that the better outcome is not guaranteed: over some whole decades, the riskier asset lost to cash.
Questions people ask
What is the risk-return tradeoff?
The rule that higher expected returns come with bigger swings and bigger possible losses. In US data since 1935, Treasury bills returned 3.5% a year with a worst year of 0.0%. Stocks returned 11.3% a year with a worst year of −39.2%.
What is the equity risk premium?
The extra return stocks are expected to earn over safe government bonds or bills: the reward for owning the riskier asset. Since 1934, US stocks returned about 8.0% a year more than Treasury bills, averaging the monthly differences.
Which investment has the lowest risk?
Short-term government debt, like 3-month US Treasury bills, and government-insured bank deposits up to their limit: their value barely moves. After inflation they can still lose purchasing power. Since 1934, T-bills returned −0.1% a year after inflation.
Read more on BigCapital
About the numbers
- The numbers on this page are recalculated from the data every night; the sources are listed at the end of the page.
- US 10-year Treasury bonds, total return index: Robert J. Shiller, Online Data (shillerdata.com), ie_data.xls, sheet "Data": "Long Interest Rate GS10", checked against "Monthly Total Bond Returns" and "Real Total Bond Returns".
- 3-month Treasury bill, secondary market rate: Board of Governors of the Federal Reserve System, H.15 Selected Interest Rates, series TB3MS; retrieved from FRED, Federal Reserve Bank of St. Louis.
- S&P Composite price and total return since 1871, and US consumer prices: Robert J. Shiller, Online Data (shillerdata.com); total return with dividends reinvested monthly, calculated by BigCapital.
- This page explains a term. It is not investment advice.