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  • Risk and Reward

    By Jerry Taylor, Full-Time Faculty, Kaplan University 
    Published April 2016

    Risk is an interesting topic; it’s actually one of those things that’s in the eye of the beholder. Some people jump out of airplanes…many people do not. Some people ride motorcycles…many people do not. People see risk very differently. Those who do not embrace risk are known as “risk averse.” We think of this in degrees, from not at all risk averse to highly risk averse. The highly risk averse, in a financial context, need to invest in things that are just about risk free, like United States treasuries. Are you a risk taker?

    What Is Risk?

    What is risk from a financial perspective? Risk is the chance you will not get some or all of your investment back. High risk means it is highly likely your investment will not perform—there is a high probability that you could lose some or all of your money.

    Investopedia defines risk as “the chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviation indicates a high degree of risk.” Wow, see how smart financial people are! 

    High Risk, High Reward?

    In return for taking a high risk a savvy investor will demand a high reward, or a high return on the risky projects. Why? A typical investment portfolio is comprised of a number of investments with varying degrees of risk. Assume half of the investments in a portfolio are risky. Further assume that ¾ of those investments will be successful and provide a high return. With a high return, the winners in the portfolio may offset the losers, those risky investments that fail to perform.

    If a portfolio is not diversified, caution must be used when selecting investments. Say to yourself, "Why is this investment opportunity forecasting a return of 15 to 25%?" These days with very low returns the numbers could even be 8% to 12%. The return is high because the market has deemed it a very risky investment. Remember what that means—chances are very good it will be a bust.

    Many investors refuse to recognize that fact and look for high reward opportunities without realizing the true nature of the risk they are taking. Many investors have lost significant nest eggs. If it seems too good to be true, it generally is.

    Instead of thinking: "High risk, high reward," we should think "High risk, potential high reward…but not likely".

    When it comes to financial risk, best follow an unnamed ancient Greek philosopher who inscribed on the Temple of Apollo at Delphi: “Know Thyself.” Financial risk can drive you insane if you are not ready for it.

    Jerry Taylor is a full-time faculty member at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.

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