Have you ever wished your money would multiply faster? That you could buy that dream home within the next 5 or 10 years? But are you prepared to understand risk and return? Are you willing to risk substantial money in the hope of getting high return? Because with every investment made, there is a potential risk involved. It’s based on the fundamental principle of risk and return.

 

Understanding the relation

Why is it that some businesspersons seem to do better than others? Or rather, why don’t some people mind taking risk and return when it comes to investment purposes? The answer could lie in the way they look at the two factors: risk and return. It is often perceived that returns on investments are directly proportional to the risk undertaken. In other words, the higher the risk and return, the more the possibility of gaining profits and vice versa (Investopedia, nd[online]).

 

Want high returns? Take the plunge!

Ever wondered why stocks and shares seem to be such great choices when it comes to investment risk and return purposes? You might be happy with your average mutual fund and the insurance policy you got from your agent. But if you want to be a maximizer of risk and return, you need to be mentally prepared to take the risk to gain sufficient returns. You need to understand the relationship between risk and return and then decide on which risk and return path you wish to take (UBS, nd [online]).

 

How much risk is involved?

You obviously want the most out of what you have invested. If you have taken on more risk and return is less you will surely be disappointed. Two factors are essential to figure out how much risk you can handle:

-          Time: If you have a year or two within which you want to buy a lavish villa, it may not be the best thing to invest in a high risk and return venture. Why? Because you risk incurring far more losses than gaining profits. On the other hand, if you have a longer time span at hand, you can be more tolerant of risk and return will also be guaranteed (Investopedia, 2003 [online]).

-          Losses: You also need to figure out exactly how much you might lose as a process of investing your money. It might make you look like a total pessimist but calculating losses sure pays off. For starters, you know what to expect in risk and return and you will be better prepared for the loss of money. Also, once you calculate the loss, you can invest in risk and return accordingly. You can put in the money that you can actually afford to lose (Investopedia, 2003 [online]).

 

The spectrum of investments

If you are still scratching your head wondering which investments fall under high and low risk and return, worry not. Here we break down the investment options into 3 categories: low, medium and high risk and return ventures.

-          Low risk: These include options like government bonds, notes, bills, cash, bank accounts etc. These have low interest rates and hence the risk and return are lower than average (Investopedia, 2003 [online]).

-          Medium risk: These include risk and return options such as real estate segment, equity mutual fund investments, high income bonds or debts, large or small capital stocks etc (Investopedia, 2003 [online]).

-          High risk: These include volatile and risky options like stocks, shares, collectibles etc. Although the earnings from these are very high, the risk and return is also steep (Investopedia, 2003 [online]).

 

The Hurdle rate

Ever wondered what obstacles you need to surmount before realizing your investment goals? Well, here we provide you a basic definition of a term in risk and return called the hurdle rate (Damodaran Online, nd [online]).

 

Hurdle rate = riskless rate + risk premium where riskless rate is the rate at which investment is made on a riskless venture. The risk premium is a parameter related to the risk and return quotient of an investment.

 

 

References:

 

Investopedia (2003) ‘Determining Risk and The Risk Pyramid’, Available from http://www.investopedia.com/articles/ basics/03/050203.asp [02/05/2003]

 

Investopedia (nd) ‘Risk-Return Tradeoff’, Available from http://www.investopedia.com/ terms/r/riskreturntradeoff.asp

 

UBS (nd) ‘Risk/Return’, Available from http://financialservicesinc.ubs.com/Home/ PWSmain/0,1093,SE77-L13166-L23167-EN3167,00.html

 

Damodaran Online (nd) ‘Models of Risk and Return’, Available from <URL: http://pages.stern.nyu.edu/ ~adamodar/pdfiles/ovhds/ch3.pdf>