Risk & Return
Risk & Return – Basic concept
”If you want to earn high returns, be prepared to take a risk from time
to time. And if you want perfect safety, resign yourself to low returns” Bernstein.
When we are young, the biggest question in our dictionary is “Where is the next party?”. During that period of time “Investment”, “Saving” etc. may be boring stuff & may be the utmost priority. But, one should Invest & save regularly for a bad time.
So when you decide to Invest, then it is important to understand Return and Risk & trade off and how to manage your risk. Before any investing, one should perform a “Risk profiling”. Risk profiling is based on your age, nature (tolerance), investment objective, family dependency etc. Risk profiling will assist you identify the type & mix of investments required to achieve your goals.
What is Return & Risk ?
In common parlance, “Investment” means putting money into an asset with the expectation of “Return”. The return can be in the form of dividends, Interest or capital appreciationof the assets. You can earn money by having your assets work for you.
The higher is the volatility greater is the danger. “Risk can be described as “volatility” associated with asset class & return. There are two types of risk i.e. “systematic risk” & “unsystematic risk”. Systematic risk cannot be reduced while unsystematic risk can be reduced by diversification. There are various types of risk are such as Interest rate, credit risk, business risk, inflation risk, liquidity risk, geopolitical risk etc. This will impact on your return & investment. Just, for example, many of us believe that government bonds, treasury are “Safe”. But, one has to understand that, there is still a risk of inflation which may “erode” the value of your capital.
Relationship between Investment risk & return
There is a direct relationship between risk & reward. Risk & return are inversely correlated. It means that the more you take a risk; more is the return. If you don’t take the risk then certainly return will be less. Now the important question is how much risk one should take. The degree of risk depends entirely on a person’s appetite for risk. To get higher returns, investors have to accept greater risk or uncertainty.
The risk and return trade of the graph. It will show that higher is the risk, the higher is the return of investment.
How to Manage Your Risk?
The risk profile is different for different kinds of investor. Your aim should be such that it meets your goals, protect your capital and at the same time maximize returns with bear amount of risk. There are a few general guidelines to reduce the risk –
- Choose an investment based on your Risk Profile & investment objective.
- Create an asset allocation based on your objective and profile. Diversify your investment. One should have Bonds, Equity, Commodity, alternate investment in his portfolio. Do not put all eggs into one basket.
- Create a balanced portfolio of savings & investment.
We have to understand one fact that it is impossible to avoid all risks when you invest. The important is to understand the risks and then keep within levels which match your risk profile. By the end of the day, it is also important to understand your nature (risk tolerance level) and your investment objective. One should feel comfortable with the amount of risk and potential consequences of investment decisions. The larger is the risk; larger is expected the return.
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