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Understanding investor risk/reward trade-offs.
The risk/reward concept states that the higher the risk of a particular investment, the higher the possible return. Although there is normally risk with any equity investment, it is important to assess just how much risk your portfolio should carry. Risk involves the potential for gain or loss of monies invested.
Many people take on more risk, hoping to achieve a higher return without regard to cyclic markets. If an investor expects higher returns on the basis of past experience, he must understand that markets can go through both periods or gain and periods of loss.
In theory, many think that the higher the risk, the more you should receive for holding the investment. With cyclic markets this is not necessarily true. Conversely in theory, the lower the risk, the less you should receive. Unfortunately, the dilemma is this: a higher potential for above-average returns comes with a higher risk of below-average returns. Conversely, safer investments, such as cash and bond instruments, have a lower potential for high returns and a higher potential to not keep up with inflation.
Different types of securities have associated levels of risk. While choosing investments for your portfolio, you need to be conscious of risk/return trade-offs and your own tolerance for risk. Every investor’s goal should be to find a balance that allows you to not experience undue anxiety in the markets and achieves your long-term financial goals at the same time.
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