What is 'Risk-On Risk-Off'

Risk-on risk-off is an investment setting in which price behavior responds to and is driven by changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns. During periods when risk is perceived as low, the risk-on risk-off theory states that investors tend to engage in higher-risk investments; when risk is perceived to be high, investors have the tendency to gravitate toward lower-risk investments.

BREAKING DOWN 'Risk-On Risk-Off'

Investors' appetites for risk rise and fall over time. At times, investors are more likely to invest in higher-risk instruments than during other periods, such as during the 2009 economic recovery period. The 2008 financial crisis was considered a risk-off year, when investors attempted to reduce risk by selling existing risky positions and moving money to either cash positions or low/no-risk positions, such as U.S. Treasury bonds.

Not all asset classes carry the same risk. Investors tend to change asset classes depending on the perceived risk in the markets. For instance, stocks are generally seen as riskier assets than bonds. Therefore, a market where stocks are outperforming bonds is said to be a risk-on environment. When stocks are selling off and investors run for shelter to bonds or gold, the environment is said to be risk-off.

Earnings, Economic Reports and Central Bank Statements Can Influence Risk Sentiment

While asset prices ultimately detail the risk sentiment of the market, investors can often find signs of changing sentiment through corporate earnings, macroeconomic data, global central bank action and statements, and other factors.

Risk-on environments are often carried by a combination of expanding corporate earnings, optimistic economic outlook, accommodative central bank policies and speculation. As investors feel the market is being supported by strong influential fundamentals, they perceive less risk about the market and its outlook.

Conversely, risk-off environments can be caused by widespread corporate earnings downgrades, contracting or slowing economic data, uncertain central bank policy, a rush to safe investments, and other factors.

Investors Give Up Returns For Safety During Risk-Off and Give Up Safety For Returns During Risk-On

As the perceived risk rises in the markets, investors jump risk assets and pile into high-grade bonds, U.S. Treasury bonds, gold, cash and other safe havens. While returns on these assets are not expected to be excessive, they provide downside protection to portfolios during times of distress.

When risks subside in the market, low-return assets and safe havens are dumped for high-yielding bonds, stocks, commodities and other assets that carry elevated risk. As overall market risks stay low, investors are more willing to take on portfolio risk for the chance of higher returns.

RELATED TERMS
  1. Risk Asset

    When an asset's value is subject to substantial volatility that ...
  2. Risk Management

    Risk management occurs anytime an investor or fund manager analyzes ...
  3. Risk Tolerance

    Risk tolerance is the degree of variability in investment returns ...
  4. Specific Risk

    Specific risk is a risk that affects a minimal number of assets, ...
  5. Corporate Bond

    A corporate bond is a debt security issued by a corporation and ...
  6. Bond Fund

    A bond fund is a fund invested primarily in bonds and other debt ...
Related Articles
  1. Personal Finance

    Risk Management Framework (RMF): An Overview

    A company must identify the type of risks it is taking, as well as measure, report on, and set systems in place to manage and limit, those risks.
  2. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  3. Investing

    Bond Funds Boost Income, Reduce Risk

    Bond funds can provide stable returns for those who depend on their investment income.
  4. Investing

    Understanding Risk is Key to Your Investing Strategy

    Here's why considering all types of risk is crucial for a successful investment plan.
  5. Retirement

    Should I Invest in Bonds After I Retire?

    Yes, retirees should invest in bonds, but remember that not all bonds are safe investments. Seek the help of a financial advisor.
  6. Financial Advisor

    Risk Tolerance Only Tells Half The Story

    Just because you're willing to accept a risk, doesn't mean you always should.
  7. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  8. Investing

    Find the Right Bond at the Right Time

    Learn about the types of bonds you should consider investing in, when you should be buying them and how to compare yields against their time to maturity.
  9. Investing

    Cash Vs. Bonds: What to Pick in Times of Uncertainty

    Learn about the benefits and drawbacks of holding cash versus investing in bonds to ensure you make the right decision about how to best safeguard your money.
  10. Investing

    An Introduction To Corporate Bond ETFs

    Learn about the pros and cons of these specialized ETFs, and get in on the opportunities they can provide.
RELATED FAQS
  1. What are the risks of investing in a bond?

    Are you thinking of investing in bond market? Learn more about bond market investment risk, including interest rate risk, ... Read Answer >>
  2. Why are mutual funds subject to market risk?

    Find out why mutual funds, like all investments, are subject to market risk, including how the different types of market ... Read Answer >>
  3. Which factors most influence fixed-income securities?

    Learn about the main factors that impact the price of fixed-income securities, and understand the various types of risk associated ... Read Answer >>
Trading Center