Risk-Adjusted Return

See: Sharpe Ratio.

The basic idea: you spent a dollar to buy a California Lottery ticket. You won a million. Million-to-one odds. And you won. Was this a good risk-adjusted return? No, not at all.

Why? Well, in fact, your real odds were not a million-to-one; they were a billion to one. You just got ungodly lucky to end up winning, and not just donating that dollar to the state teacher's pension fund. Hopefully you're now one-and-done on the whole lottery ticket buying thing. The risk was 1 in a billion, yet you returned "only" 1 in a million. That is, you were 1,000x luckier than the odds said you should have been...or for what the compensation should have been, had it equally reflected the massive risk you took.

High returns are good, but if you roll the dice often you'll regress to the mean, meaning that you'll likely basically reproduce the odds of winning in the first place. Hence it being important to know what the risks are, and what the potential returns are.

And our thought: if you ever win a lottery like this, don't ever play again. Keyword: muni bonds.