Have you gambled before?
I recently decided to step outside of my comfort zone and gambled for the first time, playing blackjack. It was me against the house, and boy did I have the hot hand – I actually won $8!
When we gamble, we are taking a risk with the expectation of increasing our earnings – seeking higher risk for a higher reward.
This is one of the foundations of finance, so please remember this forever!
HIGHER RISK = HIGHER EXPECTED RETURNS
Why is Risk & Return important?
Let’s demonstrate this concept with an example:
Suppose that one of your best friends came with a innovative new business idea that will “double your profits” if it comes to fruition. Your friend provides you with a compelling argument and you decide to invest some of your capital into the business. Understanding that the business could potentially fail or succeed, you’re taking on a HUGE risk by using your hard earned money with the expectation to double your profits.
This concept is similar in an investment context. We invest our money into different assets (stocks, bonds, real estate, etc) to generate returns on our investments. Some investments are inherently riskier than others, but we still invest in these assets with the expectation of earning a higher return.
Turning back to our scenario, would you make a risky investment with the expectation that you won’t be making a return? Nope.
In summary, we (investors) seek risk to chase the expectation of higher rewards.
I will leave you with a parting thought: How much risk are YOU willing to take to earn more money?