Four of the most common words/phrases in #Finance are interlinked. You will find people from all walks of the Financial world - be it traders, brokers, investment analysts, wealth managers, insurance agents - talking about risk, return, risk-return tradefoff, and diversification.
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Basic definitions
Risk:
Risk is negative. It is the potential loss that can occur when you undertake any initiative. It is the uncertainty in the expected outcome of your initiative.
Risk is everywhere :
Your risk losing all your savings if the bank goes bankrupt, or if the price of your property suddenly plummets due to a bubble burst, or your startup fails costing you your entire capital and time invested till date.
Usually, instruments backed by governments (bonds, T-bills) or by large corporations (like stocks, savings accounts) are low on risk.
Risk is usually measure using Standard deviation of the portfolio return.
Usually, instruments backed by governments (bonds, T-bills) or by large corporations (like stocks, savings accounts) are low on risk.
Risk is usually measure using Standard deviation of the portfolio return.
Bull market
A bull market refers to a market that is on the rise, which is a good thing. That means that prices of shares in the market are increasing. Usually a bull market also means the economy is in a good state, and the level of unemployment is low. The US is currently in a bull market .
Bear market
A bear market is the opposite of bull. In other words, the market is declining. Share prices are decreasing, the economy is in a downfall, and unemployment levels are rising.
It sounds like a bad thing (and it certainly isn't good), but Storjohann says the most important thing to keep in mind is that the market is a "rollercoaster," meaning it's bound to go up and down and people shouldn't panic every time the market looks a little ursine. "Millennials have time on their side," she explains, "and over time money has the ability to grow."
Return:
Return is positive. It is the reward you get for your efforts.
It can be the interest you earn from your deposits in a savings account, the dividend from a stock, the capital gain from selling a property at a price higher than you purchased it for.
Risk-return trade-off: The relationship between risk and return is a fairly simple direct relationship.
It can be the interest you earn from your deposits in a savings account, the dividend from a stock, the capital gain from selling a property at a price higher than you purchased it for.
Risk-return trade-off: The relationship between risk and return is a fairly simple direct relationship.
The higher the return desired, the higher should be the risk appetite. If there was an option where the risk was low for a high-return investment opportunity, everyone would flock to it, thus driving up its demand and lowering the return.
Basically, "no pain, no gain".
Diversification:
Diversification is the finance way of saying "Do not put all your eggs in the same basket".
If you invest in a single financial instrument (security, stock, bond, derivative), you risk losing all your investment. However, with judicious selection of different investment vehicles and allocating your funds in an optimal manner, you can maximize your returns without increasing your risk or exposure.
Portfolio:
A portfolio is nothing but a collection of your various investments.
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