Investing in high-risk investment opportunities may look like a quick way to supercharge your portfolio gains—but it’s more likely to kill those gains

While higher risk investments can be a strong component of growth, they are typically riskier, so you should limit your portfolio exposure to such investments.

In fact, high-risk investment opportunities are really only suitable for investors who are comfortable with the prospect of losing a big part of their investment.

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You may be surprised at the outsized gains you need to make to offset losses from high-risk investment opportunities

When they are just starting out, many investors believe they can afford to take big risks with their money. After all, if they lose money, they have decades to break even. But they overlook the way that simple arithmetic works against them when they take on too much risk.

• If you lose 10%, you need an 11% gain to break even.
• If you lose 20%, you need to make 25% to break even.
• If you lose 40%, you need to make 66.6% to take you back to where you started.
• If you lose 50%, you need a 100% gain to break even.

An 11% gain is relatively common; in fact, the market has gained nearly that much annually, on average, over the past 75 years or so. A 25% gain is a little harder to achieve. You need an above-average year to make that kind of return.

Gains of 66.6% to 100% or more can take years. Even if you make enough money to regain your losses, however, that only brings you back to where you started. You’ve still lost some purchasing power to inflation. But in addition, you’ve lost the time value of your money. You’ve missed out on the compound profit you would have made on your original stake and your profits had you invested more conservatively and made modest gains of perhaps 5% to 10% annually.

Of course, even the highest-quality, best-established stocks are likely to go down when the general market is falling. The difference is that top-quality stocks tend to recover and eventually go on to new highs. Meanwhile, they generally keep paying you dividends.

Following our Successful Investor philosophy will help to keep you out of dubious high-risk investment opportunities

Your portfolio strategy should begin with a fundamental piece of advice that we underline frequently. Spread your money out across most if not all of the 5 main economic sectors (Finance, Utilities, Manufacturing, Resources, and the Consumer sector). The proportions should depend on your objectives and the risk you can accept. The Finance and Utilities sectors involve below-average risk. Manufacturing and Resources tend to be riskier, and the Consumer sector is in the middle.

At the same time, our Successful Investor approach automatically limits your involvement in high-risk investment “opportunities,” including notoriously trouble-prone areas like new issues, start-up companies and illiquid investments. Of course, you also need to stay out of companies when you have doubts of any sort about the integrity of insiders. You also need to recognize the special risks of investing in fashionable or excessively popular minefields, such as Internet stocks in the late 1990s, or income trusts in the previous decade, or cryptocurrencies in recent years. We try to alert you to these kinds of risks in our publications, particularly our Inner Circle service.

Rather than avoiding high-risk areas, however, many beginning investors feel drawn to them. That’s because trouble-prone areas always manage to give some investors the mistaken impression that they can generate big and easy profits. Unfortunately, the risks are even bigger.

Is the added anxiety of holding high-risk investment opportunities worth it? Anxiety recedes with investment quality, diversification and balance

You’ll find that many of your worries centre on things that are unlikely to happen: They are already largely discounted in current stock prices; and they probably won’t matter as much as you feared they would. It’s also worth noting that these fears are exaggerated even more when you’re holding high-risk stocks.

We think you’ll get a much better return on time spent if you devote less of it to worrying about high-risk stocks to invest in, and more of it on a sound investing strategy. Create a strategy that is built upon analyzing the quality and diversification of your investments, and the structure and balance of your portfolio.

There’s another advantage as well. A calm investor is much less likely to react in haste and make sudden decisions that could prove to be damaging in the long run.

Use our three-part Successful Investor approach to make better investments overall, and to build a strong portfolio

We feel most investors should hold a substantial portion of their investment portfolios in securities from blue chip companies. And a good percentage of those should offer good “value”—that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above-average growth prospects, compared to alternative investments.

Here again are the three components of our Successful Investor approach:

1. Spread your stocks over most if not all of the five main sectors.
2. Invest mainly in high quality, dividend-paying stocks.
3. Avoid or downplay stocks in the broker/media limelight.

Have you taken on high-risk investments? How did that impact your portfolio?