Risk and Return (part A)
by
Charles Lamson
"No pain, no gain" is the weight lifter's saying.
The suggestion here is that muscles do not get bigger without being pushed beyond the comfort point.
While the anology is not 100 percent right on, it does get us moving in the right direction when discussing the relationship between risk and reward in investing. First, let us look at the major components of the investment formula and how they relate to each other. Meanwhile, keep the following in mind:
Risk is certain. Reward is not. How you minimize risk and maximize return is your investment strategy.
Your Personal Investment formula
The investment formula has three components:
The amount you are able to invest, either in one lump sum or over time, is an obvious predictor of the investment's outcome. Investing $500 per month will get you to your goal quicker than investing $50 per month.
How long your investment grows also has a dramatic effect on the outcome. The more time you can leave your money invested, the better chance you have of success.
The amount of risk you are willing to take will affect how quickly you reach your goal. The more risk you are willing to take, the less important are the components of time and amount of money. The following chart shows this relationship.
Relationship of Time, Risk, & Money
This relationship is not equal, because the more risk you take the higher the odds are that you will fail. When you are forced or choose to take more risk, you increase the volatility of your investments and the predictability of the outcome.
As you can see from this completely arbitrary chart, every time the "Less Risk" category is checked, the higher the odds are for success. This gives you a general idea about the relationship but is too simplistic to be the complete answer, which will be discussed in following posts.
*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, 235-235*
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