Asymmetric Risk Reward

According to conventional wisdom, you need to take big risks to achieve big returns. But the best investors don’t fall for the high-risk, high-return myth. Instead, they hunt for investment opportunities that offer asymmetric risk/reward: a fancy way of saying that the rewards should vastly outweigh the risks. In other words, always seek to risk as little as possible to make as much as possible.

A positive asymmetrical risk/reward occurs when the potential or realized reward is greater than the potential or realized loss.

Paul Tudor Jones uses a “five-to-one rule” to guide his investment decisions. “I’m risking one dollar in the expectation that I’ll make five. What five-to-one does is allow you to have a hit rate of 20%. I can actually be a complete imbecile. I can be wrong 80% of the time, and I’m still not going to lose. Superficially, I think it looks like entrepreneurs have a high tolerance for risk, but one of the most important phrases in my life is ‘Protect the downside.’ ”

  • Asset Allocation
    • There’s almost always an asset class or a country or a market that’s getting clobbered, presenting you with equally enticing opportunities for Asymmetric Risk Reward.
  • Bonds
    • Corporate bonds are typically seen as riskier (see: Asymmetric Risk Reward) than government bonds, they usually have higher interest rates. Bonds have different features than stocks and their prices tend to be less correlated, making bonds a good diversifier for investment portfolios.