Especially during bull markets, you often hear many people say: “High-risk investments bring higher returns. If you want to make more money, then take on higher risks.” In fact, it is impossible for high-risk investments to reliably generate high returns. Why? The answer is simple: If high-risk investments can reliably generate high returns, then their risk isn’t high!

The correct way to say it should be that, in order to attract capital, high-risk investments must offer higher potential returns, higher guaranteed returns, or higher expected returns, but this absolutely does not mean that higher potential returns will definitely be realized.

  1. Risk only exists in the future, and we cannot know exactly what the future will hold… When we look back at the past, the fact is clear: we know that something happened. But this certainty does not mean that the process that produced the result was clear and reliable. In every past situation, many things could have happened. But because only one thing happened, we underestimate the existence of variability.
  2. When deciding whether or not to take on risk, I first assume that the normal situation will repeat itself. Although the normal situation does occur most of the time, sometimes something very different happens… Occasionally, rare things also happen.
  3. Our predictions usually revolve around historical normality, making only small changes at most… The key point is that the average person usually predicts that the future will resemble the past, and underestimates the possibility of change.
  4. We have heard many predictions of “worst-case scenarios,” but the results are often worse. Let me tell you about my father’s story. He was a gambler who often lost money. One day, he heard that a horse race only had one horse entering, so he bet his rent money. However, halfway through the race, the horse jumped over the rail and ran away. Things always turn out worse than the average person expects. Perhaps “worst-case scenario” means “the worst case we have seen so far,” but it doesn’t mean it is the worst case of the future. The situation in 2007 was much worse than many people assumed for the worst case.
  5. Risk changes. If we say there is a “2% mortgage default rate” every year, even if the average figure over many years is true, there is still a possibility that at some point, an abnormally large number of defaults will occur, dragging down the performance of structured financial instruments. Some investors, especially those using high leverage, cannot get through this difficult time.
  6. The average person tends to overestimate their ability to measure risk, and also overestimates their ability to understand investment mechanisms they have never seen before. Theoretically, what makes humans different from other species is that we can point out that something is dangerous without having to experience it ourselves. We don’t need to burn ourselves to know that we shouldn’t sit on the stove. But in a bull market, this mechanism often fails to operate. The average person doesn’t first understand the risk; instead, they tend to overestimate their ability to understand new financial products.
  7. Finally, and most importantly, most people believe that taking on risk is the main way to make money, and enduring high risk usually brings high rewards. The market must be arranged to make it look like this, otherwise, the average person won’t participate in high-risk investments. But the market won’t operate this way forever, otherwise, high-risk investments wouldn’t be high-risk. It is only when taking on risk does not bring the desired result that people realize that this investment method truly doesn’t work, and they remember what risk actually is.