2.1 What is risk?

In the financial world, risk is measured as the spread of returns — how wide the range of outcomes can be. The most commonly used measure is the standard deviation (also called volatility): the larger the standard deviation, the greater the uncertainty about the final return.

The distribution of returns theoretically follows a bell curve (normal distribution). Each curve has the same centre (average expected return), but the width differs. With savings you know almost exactly what you'll get. With stocks or crypto the actual outcome can be far from the average, in both positive and negative directions.

This is the central principle of modern portfolio theory: investors demand a risk premium for taking on additional risk. Nobody would knowingly accept more risk if the expected return were not higher.

The upward-sloping line is the capital market line: each step to the right (more risk) brings a higher expected return. Investors who want no additional risk receive the risk-free rate (savings). Those who buy stocks receive a risk premium on top of that rate as compensation for the uncertainty.

Important caveat: these are expected returns. In practice, outcomes can deviate significantly, especially in the short term.

2.2 Portfolio Theory and Diversification

Harry Markowitz showed in 1952 that combining investments that do not move in perfect lockstep reduces the risk of a portfolio — without the expected return falling proportionally. This is the core of Modern Portfolio Theory.

The central idea: don't put all your eggs in one basket.

Correlation — the key to diversification. Correlation measures how two investments move relative to each other, on a scale of −1 to +1. The lower the correlation between two investments, the greater the diversification benefit.

2.3 Currency Risks

Most global ETFs contain stocks in various currencies — dollars, yen, pounds. As a European investor you ultimately calculate in euros. Exchange rate fluctuations then affect your return, even if the underlying stocks have increased in value.

How currency risk works — example: you buy an S&P 500 ETF.

• Purchase: S&P 500 at 5,000, exchange rate €1 = $1.10
• Sale: S&P 500 at 5,500 (+10%), exchange rate €1 = $1.20
• Result: (1.10 × 1.10 / 1.20) − 1 = +0.8% in EUR instead of +10%

The dollar weakening of ~8.3% has almost entirely eaten up the equity return. It can also work in your favour: if the dollar strengthens, you boost your return in euros.

Currency risk by region in the MSCI World:

2.4 Why Time Is the Most Powerful Ingredient

At 7% return, starting 10 years earlier yields more than doubling the monthly contribution. The last row shows that €400/mo for 20 years still produces less than €200/mo for 40 years — despite the same total investment.

2.5 Nominal vs. Real Return

Your return on paper (nominal) is not the same as what your return is actually worth (real). Inflation erodes purchasing power. If you receive 4% interest but inflation is 3%, your real return is only about 1%.

Practical examples: