The key to building the right portfolio is to balance risk and rewards. That might sound straightforward enough, but it can be deceptively challenging for most investors. Determining how to balance risks and rewards in investing looks different for everyone, and one’s own definition of risk is likely to differ from someone else’s. Risk takes on different forms and levels of influence in your portfolio depending on a host of factors.

Knowing which elements of risk have the greatest impact on your investing strategy is the most important thing smart investors can do. Undertaking the balancing act of managing risk and reward in investing means knowing the basics, understanding the role of risk in a healthy portfolio, and better incorporating risk into your portfolio in a way that makes the prospective reward worth the cost.

What Does Risk and Reward Mean for Investing?

We know that every investment comes with risk—be it an investment in stocks, bonds, or participation in a hedge fund. There is always a chance that, when you put money toward an investment, that you won’t make a return on your investment. Worse yet, there’s always a chance that you’ll be out as a result, too.

This is a broad definition of what risk means in terms of investing. You may make no money, less money, or even lose money on an investment—irrespective of what the opportunity was when you first decided to take part in the investment.

For example, let’s say you were to buy high-yield bonds (or junk) bonds. High-yield bonds offer higher interest rates than investment-grade bonds as a premium of sorts, to help incentivize people to invest in their bond. The risk here is that the company behind the bond will not be able to pay back its investors. But, on the other hand, the higher interest that high-yield bonds offer could end up giving the bondholder a higher return on their investment. The risk of not getting one’s money back—let alone making a profit on it—is larger; but the possibility of a high payout is also greater.

Why Risk Can be a Good Thing

Risk isn’t something we embrace with open arms (well, at least those of us who don’t count BASE jumping as a hobby). People are by and large averse to risk when making investments, even if risk is an inherent component of how investments make money. In fact, behavioral finance researchers call this phenomenon “prospect theory,” which is the notion that losses loom larger than gains when it comes to investing. People have a predisposition to build a financial strategy that emphasizes retaining money, rather than one that puts gains at the fore.

Despite the role of prospect theory in many investors’ methodology, almost every investor assumes some level of risk. Any time you take money out of a bank account—be it a checking or savings account—to invest in a stock, bond, mutual fund, or index fund, you’re exposing yourself to the risk that your investment will lose money.

How to Maximize Reward while Minimizing Risk

Not all high-reward investments are equally risky, mind you. Take alternative investments, for example: some are high-risk (options trading, venture capital), while others have less risk with the prospect of still garnering a high return on investment.

Take farmland investing for example: this investment class offers a unique set of opportunities that offer returns that beat Wall Street. But, unlike other investment vehicles that offer outsized returns, the level of risk that comes with farmland investing is much lower. Farmland real estate has been historically steady, and tends to hold value more than other real estate classes. Plus, with farmland investing, you can enjoy diversified revenue streams that combine real estate value and profits from harvest season—all while having your passive investment work for you.

Striking the Balance Between Risks & Rewards in Investing

Balancing risk in your portfolio means understanding how much exposure you’re willing to have to the prospect of an investment not panning out. The old adage that putting one’s eggs in more than one basket rings true here: having a moonshot investment play in your portfolio can yield massive returns, but it can also end up leaving you in a precarious position financially if things don’t come to pass.

But if you have a well-built, robust portfolio, you can avail yourself to the upside of a high-risk investment without leaving your financial strategy in tatters. Knowing your own appetite for risk means understanding how you want to build your ideal portfolio, and what you’re willing to give up if something goes bust.