Weekend Reading: Quantifying the Risk-Return Tradeoff of Investing
This article appears as part of Casey Weade's Weekend Reading for Retirees series. Every Friday, Casey highlights four hand-picked articles on trending retirement topics and delivers them straight to your email inbox. Get on the list here.
Investing doesn’t come with a clear-cut price tag. It can often be difficult to quantify the money you pay, which can also cause you to overstate or underestimate the appropriate risk level for your financial goals and needs. Read the article from The Street below.
READ THE ARTICLELoss happens: To better understand the risk of stocks and other investments, this article highlights the different variables that come along with analyzing your investment return. First, is the fact that short-term losses are inevitable, and when it comes to stocks, the cost can be many quarters of potential disappointment and losses, for long-term potential higher returns. During this period, however, even one-year losses can be substantial.
At the same time, safe government bonds, such as Treasury bills, have no recorded negative one-year returns since 1970, but the return on investment is much lower than that of stocks. And at the other end of the spectrum, small-cap stocks produce higher returns over large stocks, but at the cost of larger, one-year losses. The idea here is in order to create a balanced portfolio, you blend various levels of investment risk and return from both stocks and bonds.
Create your custom cost: Although investment price tags don’t exist, you can get a more realistic cost comparison of potential losses and risk versus returns by viewing the range of possible outcomes and their relation to your overall financial goals. Think about your risk preference and pinpoint your risk level to begin. Then, consider your goals and financial capacity for risk. Can you make up for big losses over time, or do you have limited flexibility?
For what it’s worth: As you become more financially stable, you might begin paying for luxury items you wouldn’t have considered in the past. This could include first-class flights, European autos, name-brand household goods, nicer hotels, etc. You know there is an additional price, but you're willing to pay for the convenience, reduced anxiety, peace of mind, etc. Investing is no different. The price may be lost potential for higher returns, but the value may be worth it at this point for the same reasons.