Kembara’s Financial Solutions- Risk and Reward
We have shown that savers can invest their extra cash in a number of different ways, most notably by making a bank deposit or by purchasing stocks or bonds. Why would they pick one investment over another, then? To learn more, take a look at the example below. Example Sophie wants to invest some money she has. When she hopes to use the money as a deposit for the purchase of her first home in two or three years, she wants to be pretty confident that she will be able to receive all of her money back. She has narrowed her options down to two: a two-year bond issued by a corporation that will pay 7% pa and an instant access bank deposit account that will pay 5% pa. Which one ought she to choose? The answer is that it relies on Sophie's flexibility preferences and the level of financial risk she is willing to accept. The two-year bond appears to be superior because its interest rate is 2% higher. The bond could be hazardous, though, as it might have been issued by a small business that might not have the resources to pay it back in two years. In the event that Sophie needed her money sooner than anticipated, she could do it because the deposit account has rapid access. The investment that Sophie should make will therefore depend on her preference: whether she would rather face a potentially higher risk in exchange for a higher reward, or take a lower risk in exchange for a lower gain and/or instant access. Making the appropriate financial decision is not always easy, as the aforementioned case shows. In actuality, there is always a direct correlation between the level of risk that an investor is ready to accept and the potential return on the investment. It's the equivalent of the fitness industry slogan, "No pain, no gain," in terms of money. In terms of investments, the investor's prospective degree of return will be less impressive the less likely it is that they would experience a financial loss. Risk and reward are mutually exclusive. It might be simple to distinguish between investments with higher and lower risk. In general, there would be less risk over the long run if you bought shares in an established business like Microsoft® or Apple rather than a loss-making, early-stage startup. Similar to this, investing your extra cash in a deposit account at a reputable bank is probably going to be substantially less dangerous than lending it to a friend.
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