We all know that the greater the risk, the higher the potential reward. And of course the lower the risk, the less return you’re likely to get on your investment.

But you also need to consider what your alternative is. What if you don’t take this risk? Is there an alternative that gives you almost as high a return, or will the money bring you in almost nothing if you don’t take the risk?

Let me give you an example. Suppose you’re considering investing in a volatile market for a chance of high returns. If you don’t make the investment, you could put the money in the building society where it ought to be safe (I did say ought to...). So what kind of interest is the building society paying you?

It could be 3 per cent. Then again, it could be 0.5 per cent. If it’s fairly high, your high risk investment may not be worth taking, whereas when interest rates are very low it might be your best chance of a decent return.

This concept – the overall reward you get for taking a risk, when measured against the alternatives, is called risk premium (just forget that bit if you don’t like jargon, I only put it there in case you want to know). It’s a calculation particularly worth making when it comes to short-term investments, as over the long term it can be harder to predict how the alternatives to the risk will perform.

Look back to late 2007. Then, savers could get interest rates of over 6 per cent. At the same time, the equity markets (share prices) were falling. So there was no reward, or premium, for taking the risk of investing in equities. However, once interest rates dropped the balance shifted and equities looked like a far better option than they had – and that has nothing to do with the investments themselves, but simply how they measured up against the alternatives.