The Risk-Reward Relationship: What Every Investor Should Know
By Dr. Robert Votruba
The relationship between risk and reward forms the foundation of financial markets and capitalism. It’s widely understood that achieving greater returns requires taking on greater risk. In investing, risk is defined as the uncertainty of outcomes. While some types of risk can be mitigated through diversification, achieving competitive long-term rates of return requires taking some risk.
Most often, risk is defined as volatility. The world of finance has many ways to measure this, using various metrics (such as “beta”), but the concept is easily explained with a simple example. A 3-month Treasury Bill has little volatility, because as long as the federal government is in business in 90 days, the investor is assured their money back. Today, the six-month T-Bill investor is awarded an approximate 4% rate of return[1] (annualized). Commonly, the interest rate on treasury bills is referred to as the “risk-free” rate.
The stock investor, on the other hand, does not have such guarantees. As such, the reward, over long periods of time, has been closer to 10% annualized (using the S&P 500 since 1926[2]). Thus, the stock investor is potentially being paid 5% more than the T-Bill owner to take on risk. A $100,000 investment growing at 4% over 10 years reaches approximately $148,000, whereas under a 10% assumption, the value climbs to $259,000. Spanning out 20 years, the difference widens: $219,000 vs. $672,000. Simply put, the stock investor is being paid above the risk-free rate to deal with volatility. Of course, these rates of return are not guaranteed.
The recent announcement of worldwide tariffs by the Trump administration has triggered the first stock market correction (a 10% or greater decline from recent highs) since 2023. On average, the market experiences one such correction every 18 months. This particular decline stems from concerns over the short-term economic impact of new tariffs, which are, in effect, taxes, and the uncertainty surrounding a potentially shifting global trade landscape. Markets quickly digest known information and adjust prices accordingly, but they struggle with the unknown, leading to volatility in the short term.
Thanks in large part to the so-called Magnificent Seven stocks (Apple, Google, Facebook, Telsa, Nvidia, Microsoft and Amazon), the market has been on a historic run since early 2023. These few companies have been responsible for an outsized share of the S&P 500’s returns, and by most measures were overvalued coming into 2025. This likely explains that while the recent sell-off has been broad-based, the technology sector has experienced among the deepest losses.
While we cannot predict the duration of this correction (historically, the average correction lasts approximately 115 days), we do know that the market typically experiences a bear market— a 20%+ decline —about once every six years, with the last one occurring in 2022. Unlike that period, in 2025, bonds have provided a measure of stability. Many investors may have forgotten that in 2022, both stocks and bonds declined sharply— it was the worst year on record for the bond market (-13%[3]). This time around, diversification has helped mitigate losses.
Yes, the last two years have been kind to most investors, as has the last decade. But those investors weren’t lucky, no, they were simply being compensated for the volatility they endured. Like they were supposed to be. Aside from dealing with blows to both stocks and bonds in 2022, consider what investors had to withstand only five years ago – the COVID pandemic. The S&P 500 fell by 34% from its February high to March lows – one of the fastest declines in history. Oil prices fell BELOW zero (a concept still hard to fathom). The unemployment rate rose to 14.7%, the highest since the Great Depression, and GDP declined at an annual rate of over 30%, the sharpest decline in history. Here is a glance at the market’s performance during that time frame.
Source: Yahoo! Finance
While the stock investor can never eliminate volatility, he/she can reduce it in two ways: by diversifying and through time in the market. The longer an investment is held, the less variable the outcome becomes. The following graph illustrates how volatility decreases the longer an investment is held. For instance, when examining returns over one-year periods, a portfolio consisting of 60% stocks and 40% bonds has varied from -20% to +34%, a difference of 54%. Yet the same portfolio over a 5-year holding period has a performance differential of less than half. The range of outcomes tightens yet further as time is extended.
Source JP Morgan
And now, let’s look at how this concept applies to the real world. Here is the S&P since early 2020 through today. In hindsight, the “COVID Correction” doesn’t seem as harrowing as it felt when we were confined to our homes, and restaurants were closed.
Source: Yahoo! Finance
Ten Nobel Prizes have been awarded to business minds who studied some of these seemingly simple principles. Interestingly, they all studied at the University of Chicago. Their work, chronicled in a recent movie, changed the world of investing. Through rigorous research that studied both market data and investor behavior, they found that optimal returns were achieved by having a diversified portfolio and by “tuning out the noise” (the name of the movie).
"Tuning out the noise" means ignoring sensational headlines, stock tips, and distractions that can derail long-term strategies. Admittedly, it was easier in the 1970s and 1980s when the media landscape was less noisy. Today, with 24/7 news and social media, it requires much more discipline.
Investors must also manage their own behavioral biases. Most of us are comfortable with volatility when the market is rising, but less so on the way down. Studies show that losses feel more painful than equivalent gains feel rewarding. Another common trap is Reference Point Fixation—when investors treat their portfolio's all-time high as its "true" value. This can make temporary declines feel like permanent losses, even when gains remain from the original investment.
Finding independent sources of support for the administration’s trade policy is hard. The variability of outcomes (there’s volatility again) remains so wide that seeing the endgame is impossible. Under the most optimistic assumptions, we have better trade agreements, manufacturing is reborn, unemployment falls (though it’s already near historic lows), and better-paying jobs are more abundant. Less rosy outcomes include a recession and the return of inflation.
Economist Joseph Schumpeter introduced the concept of "creative destruction"—the idea that economic growth often involves disruption. Capitalism is adaptive. Incentives and consequences drive innovation. COVID was a disruptor that changed how we live and work. Video conferencing, cloud computing, and online shopping all surged. Today, Artificial Intelligence is driving the next wave of innovation and is unlikely to be stopped by trade policy.
Times like these give investors a chance to reassess their risk tolerance. Our team assumes there will be corrections and bear markets. While market timing may be tempting, experience shows that it may be the greatest risk of all. If this recent uncertainty has you questioning whether your plan still aligns with your goals, don’t hesitate to contact us.
Should these tariffs persist (this administration has been known to flip-flop a bit), you can bet that our economy will adapt. In the meantime, things will likely remain volatile. Thankfully, you’re likely to get paid for dealing with it.
[1] Source: Bloomberg
[2] Source: officialdata.org
[3] Bloomberg Aggregate Bond Index: Source Morningstar
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. National Financial Network is not an affiliate or subsidiary of PAS or
Guardian. CA Insurance License Number - 0D23495. Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts and statements of financial market trends are based on current market conditions and are subject to change without notice. Opinions mentioned are the authors. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. Past performance is not a guarantee of future results. S&P 500 Index is a market index generally considered representative of the stock market as a whole. The index focuses on the large-cap segment of the U.S. equities market. Indices are unmanaged, and one cannot invest directly in an index. Past performance is not a guarantee of future results. 7829683.1 Exp 04/27
