Risk and Reward
Risk and Reward
Risk and reward are everlasting questions at investing, like what is better to be smart or good-looking? Well there is no universal answer to this.
The one thing is for sure, if you want higher reward, you have to take more risk. How much of risk and how much of reward, those are hard questions to answer. We have talked about risk toleration and investment goals. The risk that you can take depends on risk toleration and the required reward depends on your investments goals. If the investment market cannot offer for you a reward that you want at risk level that you can take, it means that it is just not possible. For example, if you want to lose no more than 10% of your investments but at the same time you want to have annual return more than 15% in a strong currency, then in most of the times it will be impossible.
Risk and reward ratio must be realistic, based on market conditions. Financial markets are changing all the time and risk and reward does not stay the same either. Especially the reward is changing and the most evidence of it may seem on junk bond market where yield are bouncing from 6% to 30% or more and via versa. The possible yields of stocks are changing as much just they are harder to track. But dividend yield may be some guidance in it.
The risk of bonds also changes over time, because the situation of each issuer get’s better or worse. The situation of each company (stock issuer) also is changing over time, but if we look over diversified portfolio of stocks or in other words stock market as a whole, then riskiness of stock asset class does not changes really. What is changing is attitude to some asset classes, and when fear overcomes logic stocks are dropping very fast, but it doesn’t mean that stocks became riskier. Stocks are always very risky and the fact that stock market is increasing or decreasing doesn’t change anything about risk.
Decision about the risk and reward cannot be made out of context. It depends on risk tolerance, investment goals and market conditions. Be sure that you understand the risk correctly.