Risk-on vs. Risk-off Investing: What’s the Difference?

Risk-on and risk-off investing, or RORO, describes changes in investor attitudes toward market risk in different economic scenarios. Investors’ optimism about a booming economy leads to riskier investments, making for a risk-on market. Concerns about a downward-trending market cause people to shift toward safer, low-risk investments in a risk-off market.

RORO investing is just one type of investment strategy. Other examples include bucket strategy and dollar cost averaging. It is important to note that all investments carry some risk, and investors should assess their risk tolerance before making any investment decisions.

For most people, the most effective way to invest is by adhering to a long-term strategic asset allocation designed to accomplish their investment objectives in a risk-aware fashion. Veering off course in response to shifts in market sentiment and global economic conditions is not recommended. That said, effecting modest overweight and underweight positions for certain asset classes can make sense in some situations.

Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting Professional

Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.

What Is Risk-on Investing?

Risk-on investing refers to a situation in which investors are willing to take more significant risks to achieve higher returns. An environment of strong corporate profits and an optimistic outlook during economic boom times sets the stage for a risk-on market.

During risk-on periods, investors tend to invest in higher-risk instruments, such as stocks, commodities and emerging market currencies. This behavior is driven by a decrease in perceived market risk. 

Types Of Risk-on Assets

During risk-on periods, investors tend to invest more in high-risk speculative assets such as stocks, commodities and emerging-market currencies. Investors may also choose to invest in high-yield bonds, high-growth stocks and real estate investment trusts (REITs) during risk-on periods. These types of investments have the potential for higher returns but also carry higher risks.

Risk is inherent in every type of investment. Speculative investments are short-term, high-risk investments that investors hope will increase in value in a short amount of time, providing an opportunity for profit.

What Is Risk-off Investing?

Risk-off investing refers to a situation in which investors prioritize preserving their capital by investing in safer assets such as bonds, cash and other low-risk securities. It is the opposite of risk-on investing. During risk-off periods, investors tend to avoid high-risk assets and favor low-risk investments that are perceived to be less volatile and more stable.

Types Of Risk-off Assets

Some risk-off assets include bonds, cash and other low-risk securities. These assets can be less risky because they generally offer lower returns but also carry a lower risk of capital loss. Gold is another asset that is often considered a safe-haven investment during periods of market uncertainty.

Factors Influencing RORO Investments

Various factors influence risk-on-risk-off investments, including market sentiment, investor risk tolerance and global economic conditions. Below we will explore these three concepts to better understand their impact on RORO investing.

Asset allocation, risk management, central bank policies, corporate earnings and market timing are other important factors that can help traders make informed decisions about where to invest their money. Diversification is also a major factor impacting RORO investments. It involves incorporating a variety of investments into a portfolio to minimize risks.

Market Sentiment

Market sentiment, also known as investor sentiment, refers to investors’ overall attitude or outlook toward a particular security or financial market. It can be bullish when prices are rising or bearish when prices are falling. It is often driven by emotions and feelings rather than actual performance and can cause fluctuations and price movements in the stock market.

Market sentiment can be measured using formula-based technical indicators such as the CBOE Volatility Index (VIX). The VIX is often referred to as the fear index because it measures market risks and investors’ 30-day projections for the anticipated future volatility of prices on the S&P 500 Index. The VIX typically goes up when stocks are falling and goes down when stocks are rising.

Investor Risk Tolerance

Investor risk tolerance is the level of risk that an investor is comfortable with and can tolerate. Various factors influence risk tolerance, such as financial goals, time horizon and investment amount. Investors should consider both risk and return to make informed investment decisions and ensure that their asset allocation accurately reflects their true tolerance for risk

Global Economy Influence

Global economic patterns greatly impact RORO investing. When the world economy is thriving, the market will most likely be in the risk-on mindset. Investors will strive to maximize profits by putting their money in higher-risk assets. When global markets face a downturn, the risk-off mindset is more common as investors look for the safety of low-risk assets.

Is A RORO Strategy Right For You?

Risk management tools such as risk-on and risk-off investing are not always reliable. Other approaches, such as dollar cost averaging, bucket strategy and regular portfolio rebalancing, may be more effective in the long term. A financial advisor will work with you to develop your investment strategy. 

It is essential to assess your risk tolerance before making any investment decisions. Work with a skilled financial advisor to craft an investment strategy that responds to changes in market sentiment, matches your level of risk tolerance and financial objectives.