Differentiating between High Risk Investments and Safe Investments

High risk and safe investments have very distinguishable differences. The biggest difference is the expected return, as the exchange between risk and return is the tradeoff in most investments. For example, Certificates of Deposit, which are considered some of the safest investments, have a return that sits around 4% per year, and the principle is protected by the federal government. Other investments, like options, can provide huge returns, sometimes greater than 100% per year, even with minimal amounts of capital. The risk, of course, is far greater. To receive 100% returns year over year, you would have to include a substantial amount of risk, and with options, just a few minor losses can easily wipe away your total investment capital.

The Sharpe Ratio

The Sharpe ratio is the most important tool used by fundamental investors to gauge risk. The world markets can be assessed by their risk to reward ratio, which is made simpler by the use of the Sharpe ratio. The Sharpe ratio is designed to understand risk and reward and find the potential payoff. The Sharpe ratio compares investments against the Treasury bond, which has virtually no risk and pays a low percentage rate return. Comparing the zero risk bond to a riskier investment with higher return, the Sharpe ratio helps decide if the bigger payoff is without proportionally more risk.

Just the Stock Markets

Stock markets are not as risky as they seem. Many investors hold stock portfolios all the way to retirement, and forgoing one large drop in the stock markets, it's likely that they'll end up with far more money in the end. The NASDAQ and New York Stock Exchange have moved greatly over decades. While there have been many drops and fallouts of the market, it's seemingly always rebounded to a much higher level. The stock markets are safer than they are reported to be; ownership in a company always has value, even as the rest of the stock market may be dropping.

High Risk Investments

High risk investments are generally those that are more volatile. Penny stocks are often considered high risk, as small movements in a penny stocks stock quote represent much larger percentage changes. Options and futures are also high risk, as they can be highly leveraged to pump up returns and losses greater than without leverage. Forex markets utilize leverage in the same fashion, sometimes up to 400:1. With 400:1 leverage, a .25% change in price can double or wipe away your entire investment. High risk investments show themselves through volatility; emerging markets stock portfolios should also be considered high risk due to the changing political environments in many of the world markets.

Safe Investments

You'll spot safe investments by their limited amount of risk and little return. Bonds, CDs, Treasuries all make up the list of safe investments. US savings bonds are also considered low risk, but are generally not purchased by investors because of their low returns in comparison to other treasuries and corporate bonds. Corporate bonds are considered less safe than government offerings, but generally produce a return up to 50% higher.