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Education

Understanding the Risk-Reward Spectrum

Learn how various investments offer incremental opportunities for potential returns while still mitigating market risks.

In uncertain markets, investors may hold larger than usual amounts of cash. Incremental “step-ups” in risk can potentially enhance returns while still managing volatility.

What this chart shows

Financial assets have unique risk-reward profiles. While cash carries the least risk, it also has the lowest return potential. Depending on their risk tolerance, investors can also look to bonds and equities for greater income  or capital appreciation potential.

What it means for investors

No investment is truly risk free. While cash protects principal, it is subject to inflation risk and its low returns may hinder you from reaching your financial objectives. You can step up your reward potential by prudently diversifying into riskier assets, which can help mitigate volatility while also keeping goals on course. However, it cannot assure a profit or protect against loss.

The Relationship Between Risk and Reward

The Relationship between risk and reward. The graphic shows the reward potential for cash, short term bond funds, core bond funds, high yield bond funds, and equity funds and their corresponding risk. Cash has the lowest reward potential and lowest risk. Short-term bond funds, which have relative liquidity, enhanced yield potential, and interest-rate risk, have the second lowest risk and slightly higher risk than cash. Core bond funds, which have longer-term income and appreciation potential, strong risk focus and interest rate risk, have higher reward potential than cash and short-term bond funds and have higher risk. High yield bond funds, which have greater yield and appreciation potential and default risk, have the second highest reward potential and second highest risk. Equity funds, which have the strongest long-term growth potential and market risk, have the highest reward potential and the highest risk.
Source: PIMCO. For illustrative purposes only.

Glossary of Key Investment Terms

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