Risk and Return

In Chinese philosophy, yin and yang are opposing but interrelated forces dominating the natural world. In the realm of investing, risk and return assume this dual role. They are opposing but interconnected and interdependent forces.

If you can accept that all things must find a balance between yin and yang, then so too must risk and return find a balance. When considering a particular investment, you need to examine it for its balance of risk and return.

Risk and Return

In terms of investing, "risk" refers to the possibility of losing invested capital, in whole or in part. It also refers to the volatility of the investment with respect to price changes. Risk is an integral part of investing. Generally speaking, the higher the risk, the higher the returns are expected to be to justify the risk.

Return is the increase in value (income or capital gain) of the investment, expressed as a percentage of its original value. Return often operates as a function of risk.

The percentage of return on investments can be negative (as well as positive).

The purpose of investing is to achieve your financial goals. The ideal investment would provide you with the maximum return for the minimum risk; however, realistically, a portion of both risk and return must be in every investment. Therefore, the following principles apply.

  • The higher the risk, the greater the potential for investment return.
  • The lower the risk, the lower the likely return.

As with yin and yang, risk and return can be both good and bad. As an investor you must:

  • Learn how to classify each type of investment by:
    • High, medium or low risk; and/or,
    • High, medium or low return.
  • Identify which investments will best suit your investment objectives.
  • Attempt to optimize returns with minimal risk.

Liquidity, Term and Time Horizon

In addition to risk and return,there are three other aspects of investing that you should be aware of before you start making investment decisions. They are:

  • Liquidity: the ease with which the investment can be converted into cash, with no loss in value.
  • Term: the length of time until the investment realizes its return or reaches maturity.
  • Time horizon: the  period of time during which the money will be invested (how long until you would like to have the money available) and/or the time period until your goal is realized.