Risk and Return in Investing

Risk and Return on Investing

Investment Risk

Stock investment often faces risks that are important to consider when making investments. Essentially, the risks can determine whether the expected returns of the stocks can be achieved. One major stock risk is the market risk. Notably, this risk is associated with investments declining in value due to events developing in the economy. Market risk can be further classified into currency, interest rate, and equity risks. The three influence the returns on investments made in foreign investments, debt investments, and investment in shares, respectively. Another significant risk that influences investments is liquidity risk. It refers to the possibility that one may be unable to sell their stocks at fair prices and get the money as needed, and thus, they will have to accept lower prices to sell the stock (Dahmene et al., 2021). The last risk identified is the concentration risk. It is the susceptibility to losing money for concentrating on a single stock.

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Investment Return

Various events can drive the prices of stocks up or down. One of them is the exchange rates. Notably, foreign exchange rates directly influence the price and value of stocks in foreign countries. As a result, changes in exchange rates will make the prices of stocks increase or decrease. Another event that will drive the prices of stocks up or down is the change in interest and inflation rates. When there is an increase in interest rates, investors tend to sell their high-risk stocks to acquire government securities to take advantage of the higher interest rates. Finally, the information reported in financial reports can influence the prices of stocks. For instance, when a company reports higher earnings, its stocks tend to increase in price. On the contrary, when a country reports poor performance, its stocks will decline in price.

Risk-Return Relationship

Risk and return are highly related. Usually, when the returns of an investment are significantly high, the risk involved in the investment will also be high. However, it does not guarantee that investors should accept more risk to achieve higher returns. Basically, this is so because some investments are riskier than others. Further, the relationship between risk and return is influenced by the risk tolerance levels held by investors. However, a direct relationship between risk and return remains when the efficient market theory is considered. Notably, this means that the higher the risk involved in a specific investment, the higher the return to be realized from the stock. For example, when an investor invests in long-term equities, the investor acquires the potential to recover from bear market risks and engage in bull markets.

Reflection

When making stock-investment decisions at a personal level, I would consider the relationship between risk and return. Essentially, I will consider investments with high risks having more returns. However, I will consider my risk tolerance levels when making decisions. Usually, I am highly risk-tolerant, and thus, I tend to invest in high-risk investments. The rationale for the decision-making will also consider strategies to minimize the risks and enhance the returns. Further, when making stock-investment decisions for a business, I will accept lower risks and use techniques to reduce risks. One way to reduce the risks will be diversification. Notably, this approach will entail investing in multiple stocks to minimize the chances of making losses by investing in a single stock.

References

Dahmene, M., Boughrara, A., & Slim, S. (2021). Nonlinearity in stock returns: Do risk aversion, investor sentiment, and monetary policy shocks matter? International Review of Economics & Finance, 71, 676-699.

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