Risk and reward levels are proportional to each other. It says that investors taking High risk are compensated by high rewards. It is not an easy task to determine what risk level portfolio must swallow.
Risk and Reward Compensation
When we invest our funds in any form, we expect a return on our investment. We always want to receive high return or profit on our investments. But it is not an easy task to accomplish. We are faced with risks of default and losses. This is another side of coin. When we look at this side we are reluctant to invest our funds. Then risk reward concept help us to take further step. It means return on investment is related to risk bearing. Higher the risk level more benefit or rewards are obtained. Risk level varies from investment to investment, industry to industry, company to company even country to country.
One can draw a chart of different investments showing risk and reward levels.
This would be a guideline for him. Investment with high risk level will be shown on the upper side of the chart as they offer higher return and vice versa.
Bearing Risk levels
How much risk one investor can bear or handle? This is different for each investor.
Two important factors persist here, that can help us to determine how much risk can an investor afford to handle? They are as under.
Time Horizon
It is very important to know the time frame for which you are going to invest your funds. Suppose today you invest $35,000, and in one year need this money for down payment on a new apartment, investing the money in higher-risk stocks is not the best strategy.Due to high risk level, prices fluctuate more and more volatility persists. But if your time frame is rather short, you can sell your securities to avoid further loss. If you had a more time frame let’s say 11 or more years, then you had a lot of time to cover your losses and bearing higher risk level.
Net Worth of Investor
If you have more money then your risk tolerance level is sound. It means you can take more risk. Suppose there are two persons one person has $30,000 and other have $3,000,000. Both collectively invest $15,000 in stocks. The person with lower money will suffer more if a declining trend hits stock. But if a situation concerning liquidity occurs, then investor with lower money will have to sell his securities to settle his obligations.
Investment Risk Pyramid
How much risk can be affordable for investor is determined by time horizon and his net worth. It is also important to know about risk level of instruments in which investment is made. This will help us to balance our portfolio. This tool is same like asset allocation. It provides a better view about ideal diversification. This is presented in a three layer form pyramid. It represents investor’s combination of investments.
- Base of Pyramid: This is the strongest and largest part of the pyramid. It contains Low risk Investments with estimated returns. They are safer.
- Middle Portion: This portion comprises investments with medium risk levels and stable returns. They are relatively safe but ore risky than base pyramid.
- Summit: This part contains the investments with high risk and it is the smallest area of portfolio
Different Approaches to Pyramid
Investors have different attribute towards risk. Some prefer high risks and someone are risk averse. Persons who like to take high risks they increase their portfolio size by increasing the size of summit portion and decrease the other two portions. The Portions of pyramid is based on your interests and expectations. It is important from investor’s point of view that they must be aware of the risk level. And hold securities that they can afford to tolerate. Most significantly they should consider factors of time and money and also about the return expectations for investments.
Incoming search terms:
- risk and its measurement
- investment risk pyramid
- risk and its measurements
- risk reward images
- determine risk level investment
- the risk level timframe return level
- stock determine risk level
- risk measure phots
- investment risk
- investment pyramids risk vs return
