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. Market Risk

    Market risk is the possibility of an investor experiencing losses ...
  2. Risk Discount

    A risk discount refers to a situation where an investor is willing ...
  3. Long Bond

    The long bond is a 30-year U.S. Treasury Bond, the bond with ...
  4. Safe Haven

    A safe haven is an investment that is expected to retain its ...
  5. Professional Risk Manager - PRM ...

    Professional risk manager is a designation awarded by the Professional ...
  6. Risk Premium

    A risk premium is the return in excess of the risk-free rate ...
Related Articles
  1. Investing

    The Risks Associated with Common Investments

    Investing inherently involves some risk. Here are some of the different types of investment risks.
  2. Investing

    How to Manage Risk With Bonds in Your Portfolio

    Bonds are not immune to risk, so be sure to diversify your portfolio with proper asset allocation.
  3. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  4. Investing

    Risk-On Attitude Drive Stocks and Biotech Higher

    Investors have had an appetite for risk recently, sending certain market sectors soaring.
  5. 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.
  6. Retirement

    How to Pick the Right Bonds For Your IRA

    Learn about the best types of bonds to include in an IRA depending on an investor's risk tolerance. Understand the tax benefits of holding bonds in an IRA.
  7. Investing

    Understanding Risk is Key to Your Investing Strategy

    Here's why considering all types of risk is crucial for a successful investment plan.
  8. 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.
  9. Financial Advisor

    Risk Tolerance Only Tells Half The Story

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

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
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. Is there a positive correlation between risk and return?

    Learn about the positive correlation between risk and the potential for return, and understand how risk is used to construct ... Read Answer >>
Hot Definitions
  1. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  2. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  5. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
  6. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained in a company’s financial statements.
Trading Center