Chapter 4 of 9 · 7 min read
How the Experts Do It: Balancing Reward with Risk
How putting Reward on top and Risk (Volatility) on the bottom gives us Wall Street's foundational metric, the Sharpe Ratio, and why it changes how you evaluate every investment.
Every investor should aim for good performance (reward) with low risk. How can we combine these two goals into a single number? Reward/Risk does exactly that. By putting Reward on the top and Risk (measured by Volatility) on the bottom, it combines both dimensions into one clear score. A high Reward/Risk ratio is a foundational goal for any disciplined investor.
Because Volatility (Risk) sits in the denominator of Reward/Risk, a lower volatility leads to a higher Reward/Risk. Similarly, a higher return leads to a higher Reward/Risk.
Example 1: Same Return, Half the Volatility → Higher Reward/Risk
Recall the two investments we examined in Chapter 2 (Cintas and Netflix from October 2020 to October 2025), where both delivered the exact same +123% performance, but their volatility differed by nearly 2x (23.4% vs. 43.3%). In that case, Investment 1's Reward/Risk (Sharpe Ratio of 0.81) is dramatically higher than Investment 2's (Sharpe Ratio of 0.60), which follows intuition.
Most investors completely miss this distinction if they only look at raw percentage gain. In fact, Reward/Risk is standard vocabulary on Wall Street. The formal term for it is the Sharpe Ratio (named after Nobel Laureate William F. Sharpe). It is not a perfect metric on its own, but it is vastly better than looking at raw performance, which contains zero information about risk.
Example 2: Twice the Return, Twice the Volatility → Same Reward/Risk
Now consider a second scenario. Suppose Investment 2 delivers roughly twice the performance of Investment 1, yet is also proportionally more volatile. In the end, both investments offer virtually the exact same Reward/Risk!
This illustrates how investors can be at a severe disadvantage when they only look at raw performance and ignore the Reward/Risk profile. Greed can easily dictate chasing the higher raw return, whereas a Reward/Risk ratio gives you a fair way of evaluating performance that accounts for the volatility required to earn it.
Just a simple shift from looking at raw returns to looking at Reward/Risk can transform the way you invest. It helps you uncover strong, steady investments that otherwise fly under the radar, and helps you judge whether the high volatility of a flashy asset in your portfolio is actually paying you enough per unit of risk.
Sample List of Reward/Risk Across Assets
The chart and table below show the 5-year Reward/Risk (Sharpe Ratio) of multiple well-known assets alongside their raw 5-year performance. A striking result is that the Reward/Risk ranking of different assets can look completely different from their raw performance ranking.
For example, over the 2020 to 2025 window, Bitcoin (+582%) and Tesla (+193%) returned far more in raw percentage terms than Gold (+122%), Berkshire Hathaway (+131%), or the S&P 500 (+104%). Yet on a Reward/Risk basis, Gold (1.13), Berkshire Hathaway (1.04), and the S&P 500 (0.92) all beat or matched Bitcoin (0.90) and decisively outperformed Tesla (0.66). In our 2018 5-year edition, the S&P 500 even achieved nearly twice the Reward/Risk of Bitcoin despite Bitcoin's massive raw gain. Looking at Reward/Risk protects you from greed-driven decisions and helps you allocate capital appropriately.
| Investment | 5Y Raw Return | 5Y Annualized Return (CAGR) | 5Y Volatility | 5Y Reward/Risk (Sharpe) |
|---|---|---|---|---|
| Eli Lilly (LLY) | +493.1% | 42.8% | 32.7% | 1.26 |
| NVIDIA (NVDA) | +1,222.0% | 67.6% | 52.3% | 1.25 |
| Gold ETF (GLD) | +122.3% | 17.3% | 15.2% | 1.13 |
| Berkshire Hathaway (BRK-B) | +130.7% | 18.2% | 17.6% | 1.04 |
| S&P 500 Index (SPY) | +104.0% | 15.3% | 17.3% | 0.92 |
| Bitcoin Trust (GBTC) | +582.2% | 46.8% | 69.4% | 0.90 |
| Tesla (TSLA) | +192.5% | 24.0% | 61.3% | 0.66 |
Why Medium-to-Long Horizons Matter
In general, long-term Reward/Risk ratios greater than 1.0 are rare and notable, as seen in Figure 4.2. A Reward/Risk ratio of 1.0 can roughly be thought of as earning 1 unit of annualized return for every unit of annualized volatility taken. You should prefer Reward/Risk ratios computed over the medium to long term (3 months to 10 years) rather than very short windows. Looking at Reward/Risk for a single week is noisy because one week can vary wildly from the next, whereas longer horizons reveal how consistently an investment rewards its risk.
Don't Divide Total Return by Volatility Yourself
Note that the Reward/Risk ratio (Sharpe Ratio) is not simply the cumulative multi-year percentage return divided by annualized volatility. Both the numerator and denominator must be properly annualized from the underlying return series (and adjusted for compounding and volatility drag). Avoid the common mistake of dividing raw multi-year returns by volatility on a calculator; instead, rely on a properly computed quantitative engine like EasyCompare.
Recap of Part A: Putting It All Together
Part A has given us an accessible exploration of how quantitative finance measures Performance, Risk (Volatility), and Reward/Risk (the Sharpe Ratio). This is the gateway to evaluating investments in a completely new light. Before we move into Part B (where we explore Crash/Tail Risk, Correlation, Diversification, and TrendScore), here are the four core takeaways from Part A:
- Change the way you look at investments day to day: Start checking Volatility and Reward/Risk alongside raw performance whenever you explore the market or review your portfolio. Because these metrics cannot be done on the back of an envelope, using a comparative table like EasyCompare lets you see Performance, Volatility, and Sharpe Ratio across dozens of investments in seconds.
- Use a Risk-Balanced Approach, not a Risk-Blind Approach: Paying close attention to volatility helps reduce painful losses and sustain long-term compounding1. When an asset posts huge raw returns, it attracts media hype, and most financial media has zero grasp of risk. Instead of pouring a disproportionate share of your wealth into a 70%-volatility asset out of FOMO, size your allocations according to Risk and Reward/Risk.
- Evaluate new investments soberly: Sorting and filtering by Reward/Risk and Volatility is a far more disciplined way to search for promising investments within any sector you like (such as technology, healthcare, or commodities). Combining a sober Reward/Risk lens with your fundamental thesis creates a durable foundation for investing.
- Audit the hidden risk in your existing portfolio: Many investors are unaware of how much risk exposure they already carry. Just because a company is a household name does not mean its stock is low-volatility. The goal of investing is not to avoid risk altogether, since there is hardly any return without taking some risk, but to be consciously aware of it so that investing never turns into unintentional gambling.
In Part B (starting in Chapter 5), we go a step further: how to prepare for extreme market crashes (Tail Risk and Drawdowns), how to measure true portfolio Diversification and Hedging via Correlation, and how to spot consistent Trends and Momentum.