Question

VII. Economic Risk and Diversity

Explain how "high yields" or returns might mean high risk? What are the potential risks in being in one class of assets or stocks?

Answer 1

Higher risk is associated with higher probability of return and lower risk with a higher likelihood of less return. This trade off that an investor faces between risk and return when considering investment decisions is called risk return trade off. For example , when making a decision to invest, an investor faces a risk return trade off. When he deposits all his money into a saving bank account, then he will receive a low return, i.e. the interest rate paid by the bank, but all his money will be covered up to an sum. Nonetheless, if he invests in equities, he faces the risk of losing a significant part of his money, along with the possibility of earning a much higher return than a savings deposit in a bank

Diversification is harder to achieve. For order to achieve sufficient diversification, you need to own between 20 and 100 stocks, depending on what study you are looking at. Coming back to the principle of portfolios, this means greater risk with individual stocks when you own quite a few stocks. The less money you have, the easier it is to accomplish that diversification. Especially when you start investing, due to the lack of diversity you are exposing yourself to more risk.

Monitoring your portfolio requires more attention from you. You need to make sure the businesses that you've invested in don't have business issues that could wipe out your investment. You also need to monitor trends in industry and in the economy. You are your own portfolio manager, and you have to take the time to make sure you don't keep a poor message. You have to keep the feelings in place. Selling a loser or buying a hot-tip stock is easier, as you can sign in and trade in minutes instantly. This can raise your trading fees and can also lock up losses that could have been avoided by holding something a bit longer.