Investing is often sold as a simple linear equation. Many times, we are told that if you want a higher return, you must endure more risk. The logic feels intuitive. After all, if markets are uncertain, surely the reward must be higher for those willing to endure the discomfort of increased uncertainty. But the history of finances suggests a more nuanced reality.
A real risk in an investment portfolio isn’t just the fact that prices go up and down. It is the danger that you are taking too much risk without the promise of a proportional reward. In the world of wealth management, this is known as uncompensated risk. It’s the risk that creates stress, complexity, and avoidable drawdowns without moving the needle on your financial goals.
On the other hand, some risks are rewarded over time. A stronger portfolio takes the right risks, for a clear reason, and supports your investment goals.
The challenge for individual investors is learning how to tell the difference, while still being cognizant of the mental challenges humans have concerning risk.
What It Really Means to Get “Paid for Risk”
Getting “paid for risk” means that your expected return is meaningfully higher because you accepted specific, intentional risks. To better understand risk and reward, we must first distinguish between the different types of exposure. Investors who buy a broad diversified portfolio of stocks are taking market risks.
This is generally a compensated risk because historically, the market rewards those who provide capital to the global economy over a long investment horizon.
However, many investments carry “uncompensated” risks. Consider concentration risk: putting a chunk of your assets into a single investment, such as a rapidly rising stock. While this could make you rich, it is not a risk the market pays you to take over time. While momentum can be an observed phenomenon of the market, so can the concept of reversion to the mean.
A key part of good risk management is separating repeatable drivers of return from random exposure. While luck can carry your portfolio for a while, it’s your process that carries it across decades and increases your ability to stay invested through difficult periods.
Identify the Risks You Are Actually Taking
Your investment strategy might have hidden risks that don’t show up in your daily account balance until it’s too late. Effective risk management requires understanding that risk behaves differently across various environments.
Interest Rate Risk
When rates rise, the value of existing bonds typically falls. If your portfolio construction is heavy on long-term corporate bonds, you are highly sensitive to rate risk. Many people realized this in 2022.
Inflation Risk
Holding too many conservative investments or safe investments like cash might feel secure, but the impact of rising prices can erode your purchasing power over time. The issue of affordability, such as we’ve seen in 2025 and 2026, may have caused some investors to become more conservative with their investments, at the very time they need to maintain at least some exposure to investments that generally rise with inflation over time.
Credit Risk and Default Risk
This is the danger that a borrower won’t pay you back. High-yield securities offer higher potential but come with a greater chance of default risk.
Liquidity Risk
Some investment products restrict your access to your money. If you can’t sell an asset when you need cash, you’re facing liquidity risk—a major problem if you haven’t established a robust emergency fund. This can be a consideration for investors in certain alternative or private equity-type funds.
Currency Risk
For those with foreign investments, fluctuations in exchange rates can eat into your return even if the underlying company performs well.
Spot Uncompensated Risk Hiding in Plain Sight
Some of the most damaging risks are not obvious.
Many portfolios suffer from “implementation drag”, which means you may be incurring risks that don’t offer a reward. This often includes:
- Concentration: Owning too many overlapping mutual funds or funds that create noise and higher costs without providing true diversification. Many investors don’t realize how many funds and ETFs hold the same securities.
- Performance Chasing: Rotating into different investments because they did well over the last 6 months, 12 months, or any prior period you choose. Historical returns are just one instance of what could have happened in the past, and we need to be careful trying to project history forward into the future.
- Overcomplication: The more parameters and risk indicators you use to create the “perfect” risk and reward balance, the more unaware you will be of the hidden dependencies and interactions between them. This creates a greater tendency to “curve fit”. Life rarely plays out to such precision.
Measuring Risk the Right Way (Not just by Volatility)
Many investors focus on volatility, but volatility is not really risk. It may be an indicator of risk, but it is only a surface-level metric. It is something we can measure, so we tend to use it to describe risk. Drawdown risk and sequence of return risk are other metrics and events that we can measure to determine their impact on a portfolio’s growth, but they still may not align with your specific situation. Probably the best definition of risk I have heard comes from Howard Marks, who stated that:
“Risk is probability of a bad outcome”.
While anyone can calculate volatility (or what they call risk) metrics from past data, success really comes down to just risk metrics; it comes down more to risk capacity. And everyone’s risk capacity is different.
It is based on your own capacity to emotionally and financially endure a bad outcome, at various times in the future, based on your situation and goals. You should ask not only what the probability of a bad outcome would be, but also of those unfavorable outcomes, which ones would you be most likelyto be unable to recover from. This is the essence of the Porter Investment PPRO Investment Process.
Check Whether Your Return Drivers Match Your Goals
A portfolio’s return drivers should match its purpose.
Some portfolios are designed for growth. Others for income. Others for preservation. Many blend all three. Problems arise when risk is taken for reasons that have nothing to do with the objective. If your financial goals require stability in the next few years, taking much risk for incremental upside may not make sense. If your timeline is long and cash needs are distant, taking little risk may quietly jeopardize long-term success. The right question is not “How aggressive is this portfolio?” It is “Does this risk profile support what I am trying to accomplish?”
All investment strategies eventually come down to a simultaneous balance of return, risk, and time.
The Cost of Risk: Fees, Taxes, and Implementation Drag
Not all risks show up in prices, trading volumes, and volatility. Some risks, while not readily visible, can quietly become a drag on a possibly greater appreciation.
- Fees – Excessive fees reduce the return you keep. There is nothing wrong with paying for specific expertise, but you do not need to pay an advisor to hold an Index fund.
- Activity – Occasional rebalances to keep a proper asset allocation are prudent. Trading multiple times per week can increase taxes. Many online trades can be free at brokerage firms, but they are never free from the IRS. Over time, this friction can add up.
- Implementation – If your strategy requires exact timing to implement, your timing will invariably be off, and the cost of implementing with such exactness might be hard to justify. As mentioned earlier, life never unfolds with such precision.
Just remember that each security holding should have a job. If an investment adds complexity, cost, or tax friction, it must earn its place.
Build a More Intentional Risk Budget
An intentional investment strategy can start with creating a broad risk budget.
- Define how much downside you can tolerate without changing plans or behavior. Aligning portfolio construction with your near-term needs, your mid-term flexibility, and your long-term growth.
- Like a family budget, establish some guardrails. These are thresholds that you will not go beyond, that will prevent dangerous drift into unintended risk.
- Always remember those risks where you are not adequately compensated.
A truly diversified portfolio balances sources of risk rather than just collecting more holdings.
When to Reassess Risk (And What Should Trigger a Review)
There are at least 4 times when your portfolio risk should be reassessed:
- Major personal events like retirement timing shifts, job changes, inheritances, business sales, or large purchases can alter financial strength and liquidity needs.
- Major market events. Large run-ups, sharp drawdowns, or major rate changes can change both opportunity and exposure.
- Portfolio-specific events. These would be things like multi-year gains that create concentrated gains. This goes back to prudent asset allocation and rebalancing.
- Your emotions and behavior start to take control. If headlines dominate your attention, you constantly check accounts, or you continually worry about what a 10% correction would have on your ability to meet your goals, your portfolio may be taking more risk than your plan can support.
Portfolio Risk and Return FAQs
1. What does it mean to be paid for risk?
To be paid for risk means that the risk you take has a reasonable expectation of improving long-term outcomes, not just increasing volatility.
2. Can a diversified portfolio still lose money?
A diversified portfolio can still lose money, especially in the short term. Many people think they are diversified when they construct a portfolio of non-correlated assets. This is true over the longer term, but in times of severe market stress, many assets can go down in price together.
3. Is volatility the best risk measure?
Volatility is not the best risk measure, but many people use it because we can calculate it from past data. A better measure of risk is how likely an investment or a portfolio, over a specific time frame, will have a return outcome that you will not be able to recover from, either financially or emotionally.
4. How often should risk be reviewed?
Risk should be reviewed annually, whether you think you need it or not.
How We Help Clients Make Risk More Intentional
At Porter Investments, we start by identifying the investment risk you are actually taking, and not just the volatility you see on a chart or in a beautifully presented backtest.
Our structured portfolio construction aligns your portfolio with your risk tolerance, your risk capacity, and real-world possibilities, so the amount of risk you take supports your life and not your stress.
Uncompensated risk is one of the quiet killers of portfolio success. Our introductory process strives to make sure you receive proper payment for the risk you take. Get in touch with us today.
Bob Porter is the President of Porter Investments. Porter Investments is a fiduciary investment management firm based in Houston, Texas, helping self-directed and hybrid investors gain professional guidance and grow their portfolios with tactical strategies. Bob's prior work at Fidelity Investments allowed him the opportunity to advise and study a diverse group of investors.
