And, Warren Buffett has argued that there are cases where taking less risk leads to higher returns.
I also believe that their is too much focus on short term volatility and not enough focus on the risk of long term real (after inflation) wealth risk.
A higher risk investment has a higher potential for profit but also a potential for a greater loss.I may choose the safe route and expect a lower return.As discussed above the concept of being able to accurately keyway designs discount code and quantitatively measure risk is more false than true.Capm indicates that taking risks that could be diversified away will not be rewarded.This is based on individual preferences and the average market risk premium does not imply that individuals should accept that level of premium as creating an equivalency.Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns.That said, the risk-return tradeoff also exists at the portfolio level.Risk Fallacy Number 2: All types of risk will lead to a higher expected average return.But studies have shown that beta varies over time, therefore it is not clear that beta can be actually measured.In other cases, both your capital ans the return, or the money your investment makes for you, are guaranteed.
The second thing we need to understand about the relationship between risk and reward is that there in many cases there is no relationship.
This fallacy is based on the fact that 6, 11 and 16 are the market rates of return for this risk level as set by capm or the Security Market Line (SML).
Measuring Singular Risk in Context and Portfolio Risk Level.
Another problem with the concept of talking about a risk adjusted return is that it would be necessary to be able to measure the risk of an investment before we could state what its risk adjusted return.
False, if a higher return was assured than it would not in fact be risky.For example, a penny stock position may have a high risk on a singular basis, but if it is the only position of its kind in a larger portfolio, the risk incurred by holding the stock is minimal.The person who invests in the market at 11 and earns that over a lifetime expects to end up with a lot more money in the end but puts up with more volatility along the way.Within an all-equity portfolio, risk and reward can be increased by concentrating investments in specific sectors or by taking on single positions that represent a large percentage of holdings.Examples of high-risk-high return investments include options, penny stocks and leveraged exchange-traded funds (ETFs).
But before anything else, you need to know what type of investor you are!