What Are The Risk And Reward In An Investment

High risk = high return, low risk = low returns

But why?

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Every investment carries risk along with it, whether the investment is in the form of cash, share, bond or any other physical assets such as property. The level of risk associated with these investments varies from time to time. Some months market can be optimistic about a particular stock and extremely pessimistic the following month.

You should consider the risk profile before buying that asset. Five main types of risks can dramatically effect your portfolio returns.

  1. Risks of capital loss– when a company you invested in performs poorly over 2–3 quarters. Market outlook can change on the performance of that company. It may be challenging to find a buyer at the price you’d like to sell. As a result, the selling price of your holding can be significantly lower than the price you bought at. In an extreme case, the company you invested your hard-earned money into goes out of business. You will no longer be able to sell your holding as the business no longer exists on the share exchange when a company goes into administration or files for bankruptcy. If a liquidator is hired to recover the investment principle, supplier and creditor will be paid before you receive anything at all.
  2. Volatility risk– Share price can fluctuate from one extreme to another in a matter of days. If you don’t have the stomach to handle the volatility regularly, you’ll be buying high and panic selling when the stock price takes a nosedive.
  3. Timing risk– Markets operate in cycles. Businesses have long term and short term cycles, In which share price can go up and down depending on where the business is in that cycle. All companies react differently to the cycle. Some may be very sensitive to the other companies may not be as reactive. Understanding the business cycle and how companies respond to it can help you manage timing risk.
  4. The risk of poor quality advice– Investment recommendations made by friends, the family that they are so hyped about that they cannot stop talking about. Some red flags are when they’re guaranteeing extraordinary returns. Stop and do your own research when your own money is at risk.
  5. Legislative and currency risks– Your investment can be impacted by changes in current law. The changes can be in or out of your favour. Currency risk comes into effect when you have investments outside of your home country. When you need to bring the profit from investment back to your home country, the gain needs to be converted into the currency supported by your home county.

Your risk appetite can change based upon your goal and your age. You are more likely to take on a more risky approach when you’re younger than someone in the same position as you but much closer to retirement age as they have more time to recover from their losses.

When you take low risk on your investments, it is safe to say that you’ll yield less return. However, it doesn’t mean that you’ll get a higher return on those investments if you take an increased risk. Take on risk but not to the magnitude where your portfolio is wiped out entirely if the risk blows over.

When making investment decisions take other factors into account to improve your forecast of that company. Some other factors are the economy of the company you’re investing in, the interest rates, investor sentiment, how do overseas economies effect your investments, government policies, the price of commodities in the sector relating to your investment, consumers confidence, and level of unemployment (I prefer a low rate of unemployment but not too low or wages will rise — excessive wages growth can trigger inflation)

The stock price is determined by the demand and supply of that stock at any given time.

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