One cannot but encounter the fact that each person can choose to invest funds in various financial products. Arguably, some investments pose maximally low risks, yet the efficacy of these investments will not be high enough to guarantee good returns. Some other investments, however, may increase the chance of getting much higher returns; in any way, the likelihood of losing money on these investments should not be underestimated as well. Speculating upon the relationship between risk and return, it should be viewed as directly proportional to one another. To make it clear, when an individual aims to make big profit, he/she has to understand a dire need for risking something valuable. Likewise, the unwillingness to put substantial money at risk will result in being practically unable to make good profit.
It is imperative to remember that absolutely all investments can be characterized by carrying both risk and yield return. As it was mentioned before, one cannot help but become aware that risk and return appear to be inherently related, and it is impossible to separate these two financial concepts when contemplating upon potential investments. Nonetheless, a general understanding of the correlation between risk and the potential return cannot exclude the chances of making inappropriate investing decisions. The focus here lies in arguing that there is a dire need for an in-depth quantifiable analysis, which would allow grasping the idea of investments better. In regard to quantifiable analysis, it rests upon the findings obtained from mathematical and statistical methods. Considering a return from investing certain amounts of money, it can predominantly be calculated by taking away the original sum invested from the overall amount gained. Significantly, there is an opportunity to determine returns for either a concrete period of time or for the overall period. For instance, in case an individual invested $70 and managed to receive a return of $20 during the same year, and eventually got $200 as a result of selling his/her investment, returns can be seen as follows:
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Absolute Profit for 5 years = $20 + ($200 - $70) =$150
Average Profit for 5 years = $150/5 = $30
Profit Percentage = $150 * $100 / $70 = 214% return
Average Profit Percentage annualised = 214%/5 = 42.8%
Regarding the financial concept of risk, it comes to directly refer to either dispersion or derivation of returns from average rate of returns. A peculiar thing is that risk can be easily determined by using standard deviation.
Speaking about bonds and common stocks, one has to take into account the fact that they emerge to be the two pivotal types of assets that investors utilize to invest for total return. In particular, stocks should be identified as basically proffering an ownership stake within the organization, whereas bonds have much in common with loans given to an enterprise. On the whole, it is important to highlight the fact that stocks occur as much riskier in comparison to bonds. Notwithstanding this, there is a variety of different types of stocks and bonds, and their levels of risk and return are far from being uniform, respectively. Although stocks are qualified as riskier, it is necessary to know that they are also strongly associated with much higher returns. According to numerous surveys, it becomes apparent that corporate bonds typically offer low risks and good returns, providing that investors come across appropriate enterprises to invest resources. Specifically speaking, corporate bonds are known as nearly risk-free assets due to the fact that in the event of bankruptcy, they give investors extra confidence that their invested resources will be returned. For all that, bonds offer relatively lower returns on investments, which in turn results in investment professionals choosing stocks as a more preferred component of their portfolios.
When an individual takes a decision to invest, he/she is involved in facing the need to ascertain how to deal with financial assets. Apparently, risk should be referred to as any sort of uncertainty in respect to the inflow of cash that may contribute negatively to one’s financial condition. In other words, it refers to “ situations in which it is possible but not certain that some undesirable event will occur” (Hansson, 2002, p. 10). For instance, the investment value can vary depending on changes in business environment; and ideas on whether to stop investing in a certain business or continue to expand into the same field of industry can pose serious threats to the value of a property to investment professionals. To be precise, getting into international investing, for example, implies the bulk of business risks that deserve to be thoroughly addressed in advance; and of all business risks, currency instability and political unrest are those that investors should consider as the biggest threats.
There is a number of other serious business risks, including the one that consists in being unable to mach short term financial demands. Apart from liquidity risk, a failure to diversify the capital into different investment vehicles occurs as another risk factor. The thing is that the more you invest in a single area, the greater risks you are likely to face. In sum, adequately responding to possible risks and putting “things in a global perspective” (Fisher, 2005, p. 2) can negatively affect decision making process. Yes, investors have to expand their insight into some fundamental financial concepts in order to minimize the probability of negative financial surprises. One has to be conscious that the level of investment risk is usually directly linked to the level of return. The last but not least, interpreting risk and return must rely on being aware that those taking higher risks deserve to be eventually rewarded.
References
Fischer, D. I. (2005). A Step Backward Might Be a Good Thing. Financial Analysis Journal, 61 (4), pp. 20-23.
Hansson, S. O. (2002). Philosophical Perspectives on Risk. Techné: Research in Philosophy and Technology, 8, pp. 10-35.
