Understanding risk and return in simple terms

A friend called me around midnight a few nights ago. Travelling alone in a cab, she informed me that her mobile data was down, so she couldn't share her location. Exhausted, she was on the verge of falling asleep - her parents thought she was at my house, but she was still an hour away.

To keep her awake, I made small talk about finance. The irony isn't lost on me, don't worry.

'You earn so much, why don't you invest the money you save?' I asked.

'Dude, it's too risky.'

I hope the irony isn't lost on you either.

This isn't just one instance. Gripped by the fear of risk, many of us avoid investing to not lose money. Yet, somehow we overlook the certainty of inflation eroding the value of our savings. The 2022 DSP Winvestor Pulse Report found that among its participants, 67 per cent of women consulted their spouse for investment decisions and only 26 per cent invested independently. Prioritising safety and stability, women showed a preference towards bank fixed deposits. The biggest hurdle toward independent investing was quoted as a lack of confidence in financial knowledge.

Risk and returns aren't the villains they're made out to be. Understanding them is the first step to investing with confidence. Let's clear the misconceptions - because smart investing isn't about avoiding risk, it's about managing it.

The relationship between risk, return, and time

Risk is everywhere but we manage it daily.

Travelling alone at night? Risky. Ordering sushi from a new restaurant? Risky. Wearing white while eating butter chicken? Extremely risky.

But do we let that stop us? No. We simply navigate around it. We share our location, check restaurant reviews, and buy good laundry detergents.

Investing is the same.

Many people mistakenly equate risk with loss. But risk doesn't mean you will lose money; it means that there is a chance you might lose money.

How do you navigate risk in investing? By mostly letting time do the job. Historically speaking, over long periods the likelihood of losing money reduces significantly. The BSE Sensex (a leading stock market index) has weathered crashes, recessions, and global crises — yet, over decades, it has consistently moved upward.

Suggested read: Understanding risk vs return

Every investment has some risk

All investments carry risk, but they vary in terms of how much risk and how much potential return they offer. Here's a comparison:

Suggested read: Common sense about risk

Understanding returns

Returns simply mean the amount of money your investments generate. If you want higher returns, you need to accept some level of risk — it's a fundamental principle of investing. No risk, no reward.

Think about learning an instrument or coding. Starting is tough — slow progress, mistakes, frustration. But those who stick with it? They master it. Investing is the same - the longer you lock in, the more time you give your money to grow, and the better your results.

How to manage risk and still earn good returns

The right strategy is not to avoid risk but to prepare for it. Here are a few things you can do:

1. Diversify : Spread your money across different assets (equity, debt, etc.) so that no single loss hits too hard. This works because different assets react differently to market events. When one asset falls, another might rise, balancing out risks.

2. Invest regularly : Instead of waiting for the "perfect time," use Systematic Investment Plans (SIPs) to invest small amounts consistently. This averages out market fluctuations and reduces risk.

3. Think long-term : Markets go up and down, but history shows they rise over time. Staying invested for longer reduces the impact of volatility.

Final takeaway: Don't fear risk, learn to manage it

Risk exists in everything but we manage, adapt, and move forward. Investing is no different. The key is to start small, stay consistent, and trust the process.

Let time and effort build your confidence and knowledge. The best way to learn investing is to begin.

Also read:
Mutual funds: The most hassle-free investing option
SIP: The smartest way to build wealth

This article was originally published on March 06, 2025.