Lesson 1 of 8
Risk and return: the trade-off
7 min read
Return is the payment you receive for accepting uncertainty. There is no version of investing where the payment exists without the uncertainty.
The main asset classes
- Cash: no volatility, guaranteed loss of purchasing power if inflation exceeds the interest rate.
- Bonds: lending to governments or companies for interest. Lower expected return, sensitive to interest rates and to the borrower defaulting.
- Shares (equities): part-ownership of businesses. Highest long-run expected return, and large falls along the way are normal rather than exceptional.
- Property: rental income plus price movement, with illiquidity, transaction costs and concentration in one location.
The pattern is consistent: the higher the expected return, the wider the range of possible outcomes.
Volatility is not the same as risk
Volatility is price movement. Permanent loss is what happens when you sell after a fall, or when the underlying asset is genuinely impaired. For a long-term investor, volatility is the entry price - it becomes a real loss only when it forces or tempts you to sell.
Capacity versus tolerance
Risk capacity is objective: your time horizon, your job security, your other assets, whether you would need this money in a bad year. Risk tolerance is subjective: whether a 30% fall would make you sell everything at the bottom. A sensible plan respects the lower of the two.
Money with a short horizon does not belong in markets
If you need the money within about five years, market risk is inappropriate regardless of your tolerance for it. Deposit for a house next year is a cash question, not an investing question.
Before you invest at all
Clear expensive debt, build an emergency fund, and capture your employer pension match. In almost all circumstances those three beat any investment return you might realistically achieve.
This is education, not advice. mySal cannot tell you what to buy.
Key terms
- Volatility
- How much a price moves up and down. Not the same as losing money permanently.
- Risk capacity
- How much loss your circumstances can absorb, regardless of how you feel about it.
- Risk tolerance
- How much loss you can live with emotionally without abandoning the plan.
- Asset class
- A category of investment - shares, bonds, property, cash - with its own risk and return profile.
Quick check
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Homework
0/3 doneThree small jobs. They take minutes and they're what makes the lesson stick.
- 1
Make it personal
In two sentences, write what "Risk and return: the trade-off" changes about how you handle your money this month.
- 2
- 3
Teach it back
Explain the main idea of this lesson in plain English, as if to a friend. Write the explanation you would give.
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Your notes
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