How much money do you want to make while investing your money? Are you trying to keep pace with inflation, or taking on more risk for a bigger return? Your answer to these questions will determine your risk and return preferences. Risk – Return are the underlying factors affecting the market’s returns. It’s important you know how risk and return affect each other when making investment decisions.
The Risk – Return Concept is Simple: The More Risk You Take On, The Higher Your Expected Return
So, what is risk?
Risk is the chance of losing your initial investment while investing. Companies with more risk have a higher chance of losing money compared to companies with lower risk. Here’s the thing, if you want to make more money (higher returns), you have to invest in riskier investments. This is why you need to know your desired levels of Risk and Return.
If you have extra money that you aren’t dependent on for other things, then you might take on the higher risk. Also, the younger you are, the longer your investment horizon is: You have more time to ride out the market lows to receive the average return. On the other side, if you are older, you might not want to take as much risk, especially if you need the money for your retirement years. In this scenario it’s safer to protect your wealth with less risky investment.
When discussing returns you must consider the risk that was involved to get that return
Someone might think they did great in the market because they matched the market return of 10%, but how much risk did they take on? If you invested in really risky assets and only receive the market return, your investments didn’t actually perform to what they were supposed to, considering the risk. If someone is talking about how they did well in the market this year, ask them how much risk they took on. Risk – Return together will determine how well your portfolio performed.