Question

Discuss the relationship between risk and reward when investing.

2.  Describe your investment strategy for the simulation and evaluate how well it worked. As a result of this simulation, what, if anything would you do differerently if you played a new stock simulation in the future? Why would you make the changes you described?

3. Based on what you read in chapters 11, 12,& 13 describe the characteristics of an ideal investment portfolio. Why do you think these characteristics help to create an ideal portfolio? How should a portfolio change over time, especially as a person nears retirement?

4. Discuss the pros and cons of managing your own portfolio vs. having an investment "professional" manage your portfolio. (hint - several of my instructor postings have information related to this topic.) Google search: What percentage of investment managers actually earn higher returns for their clients than the market average? What is the best way to increase the chance that your portfolio will at least earn the market average?

5. What was the most interesting or surprising thing you learned as a result of this activity?

Answer 1

The relationship between risk and reward when investing

The risk-return relationship states that the potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns. According to the risk-return relationship, invested money can render higher profits only if the investor will accept a higher possibility of losses.

The risk-return relationship is the trading principle that links high risk with high reward. The appropriate risk-return relationship depends on a variety of factors including an investor’s risk tolerance, the investor’s years to retirement and the potential to replace lost funds. Time also plays an essential role in determining a portfolio with the appropriate levels of risk and reward. For example, if an investor has the ability to invest in equities over the long term, that provides the investor with the potential to recover from the risks of bear markets and participate in bull markets, while if an investor can only invest in a short time frame, the same equities have a higher risk proposition.

Investors use the risk-return relationship as one of the essential components of each investment decision, as well as to assess their portfolios as a whole. At the portfolio level, the risk-return relationship can include assessments of the concentration or the diversity of holdings and whether the mix presents too much risk or a lower-than-desired potential for returns.

When an investor considers high-risk-high-return investments, the investor can apply the risk-return relationship to the vehicle on a singular basis as well as within the context of the portfolio as a whole. Examples of high-risk-high return investments include options, penny stocks and leveraged exchange-traded funds (ETFs). Generally speaking, a diversified portfolio reduces the risks presented by individual investment positions. 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.

That said, the risk-return relationship also exists at the portfolio level. For example, a portfolio composed of all equities presents both higher risk and higher potential returns. 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. For investors, assessing the cumulative risk-return relationship of all positions can provide insight on whether a portfolio assumes enough risk to achieve long-term return objectives or if the risk levels are too high with the existing mix of holdings.