Why investors overestimate returns and underestimate risk

Why returns seem like the main metric

When choosing an investment strategy, investors most often focus on returns. This is understandable: the metric is clear, easy to compare, and directly tied to profit expectations.

However, this is also where the key mistake lies. Returns show the outcome but do not explain how it was achieved. Without analyzing risk, this metric provides an incomplete picture.

Where the misperception lies

In practice, investors tend to:

• focus on the best historical periods
• project past results into the future
• ignore drawdown periods

For example, high returns over a year are often perceived as a stable result. At the same time, the following factors are overlooked:

• the level of risk taken
• the depth and duration of drawdowns
• the dependence of results on market phases

As a result, investors evaluate not the strategy itself, but its most successful period.

Why risk is underestimated

Risk is harder to perceive for several reasons:

• it does not always materialize immediately
• during growth periods, it is barely noticeable
• it cannot be expressed by a single simple metric

Until risk materializes, it seems insignificant. That is why strategies with higher returns and hidden risk often appear the most attractive.

The illusion of stable returns

Special attention should be given to strategies with visually “smooth” returns.

At first glance, such performance appears to indicate stability. In practice, however, it may signal:

• shifting losses into future periods
• lack of loss realization
• aggressive position management
• accumulation of hidden risk

The absence of drawdowns in long-term statistics is not an advantage, but a reason for deeper analysis.

Returns and market phases

Any strategy operates in a changing market environment. Markets go through different phases:

• growth
• corrections
• sideways movement
• periods of uncertainty

High returns may be the result of favorable conditions rather than a robust strategy. It is during difficult periods that a strategy’s true resilience becomes evident.

Practical consequences

Underestimating risk leads to common investment mistakes:

• choosing overly aggressive strategies
• increasing investment volume without considering risk
• lack of diversification

As a result, even moderate market changes can lead to significant losses.

The approach of professional market participants

In professional environments, priorities are structured differently:

• risk is assessed first
• then the strategy’s robustness
• and only then returns

This approach helps avoid situations where high returns are achieved at the cost of excessive risk.

The IQ Security Fund approach

At IQ Security Fund, primary focus is placed on risk structure and strategy resilience.

Evaluation is conducted across several levels:

• risk control in each trade
• analysis of drawdowns and their duration
• assessment of return volatility
• strategy behavior under different market regimes

Returns are viewed as the result of this system, not as an end goal.

How investors can change their approach

For a more objective evaluation of a strategy, it is important to shift focus from returns to risk. In particular, investors should consider:

• the depth and frequency of drawdowns
• the stability of results
• the structure of returns
• performance under adverse conditions

Only a comprehensive analysis allows for well-founded investment decisions.

Conclusion

Overestimating returns and underestimating risk is one of the key causes of poor investment decisions.

Returns show potential profit, but risk determines the sustainability of results. In the long run, the ability to control risk becomes the decisive factor.