The Price of the stock is what you pay to buy an asset or what you get when you sell an asset in the market. Return refers to the amount of money you make from your investment, expressed in % terms. Risk is the probability of the likelihood of you losing your money. Price, Risk, and Return share compelling relationships. Knowing and fully understanding this relationship is crucial for great Investment Analysis & Portfolio Management. A greater probability of higher return is associated with higher risk, and a greater probability of lower return is associated with lower risk. The investor faces the tradeoff between risk and returns while taking an investment decision called a risk-return tradeoff. The firm and individual must compare the expected return from a given investment with its risk. E.g. Seema invested 6,00,000 in a Fixed deposit with an expected return (interest rate) of 5% for one year. Here, the return is fixed throughout the year, so the risk is lower. Alternatively, suppose Seema invested 6,00,000 in equity share of XYZ company. In that case, there is a higher probability of losing a major chunk of her capital and a higher chance of getting a higher return than a fixed deposit in a bank. Hence, higher risk = higher return. Risk and Expected return maintain a proportional relationship. As risk increases, the expected return increases. Investors needs to understand their risk tolerance and should design a portfolio that will benefit them in a long run. Risk Tolerance is often associated with the age. The younger people are considered more risk-tolerant as they have a longer time horizon in front of them and therefore more likely to invest in highly risky instruments like equity rather than instruments with fixed income. People in their older age are more likely to invest in more safer instruments so they will go for fixed income instruments which will have lower rate of return as compared to equity but they are assured that they won’t lose their principal amount. Albeit, there could be some exception, an individual in his old age having higher net worth can afford to take higher risk and can wilfully invest in risky securities.
Choose your relationship with risk carefully, so that your returns don’t pay the price.
Concept: Almas Shaikh Editor: Minakshi Agrawal Todi