Relationship Between Risk And Rate Of Investment
The Relationship between Risk and Rate of Return …show more content…
Consequently, an investor upon being compensated by higher expected returns would take on increased risk. If an investor who wants higher expected returns, on the other hand, they must accept more risk, which means that the exact trade-off would be realized for the investors.
Moreover, to assemble an efficient portfolio, an investor would need to diversify to mitigate risks. Diversification involves taking advantage of differences in risk within one’s investments due to changes in value at different times over different directions. Therefore, a portfolio consisting of several different investments where only one of them loses value, the portfolio is better than a single investment since it loses a smaller percentage of its value.
To diversify effectively, one would combine multiple asset classes with high expected returns and low correlations and smoothed out with asset classes that have low correlations to domestic indices, such as commodities and bonds. The portfolio should attain a high percentage of returns with minimal volatility of the …show more content…
As such, diversification makes it possible for one to reduce the risk for the same portfolio’s expected return. It is thus crucial to spread one’s money around to guard against losing all the assets in a market swoon. For instance, the sharp decline in stock prices has proven risky, and as a result, an investor would diversify into bonds and mutual funds. However, one should have a strong conviction on the kinds of investments to buy and the amount of money to put into each venture, as well as the diversification method within each investment category.
For an investor portfolio to be properly diversified, it needs to involve different kinds of investment rather than having a lot of investments at once. Therefore, one should have some of all of cash, international securities, real estate funds, bonds, and stocks. Upon diversifying by putting the assets into different categories, an investor would need to diversify again. For example, if it is stocks one wants to invest in, it is not enough to buy one stock, as different types of stocks in that portion of the portfolio would be more apt to protect the investment from getting shrunken when a single industry