To get profit without risk, experience without danger, and reward without work, is as impossible as it is to live without being born. – A.P. Gouthev
Two key concepts provide the foundation for the field of finance.
1. A dollar today is worth more than a dollar tomorrow – this is the time value of money.
2. A safe dollar is worth more than a risk dollar.
The trade-off between risk and return is the principal theme in the investment decision.
RISK AVERSE: Most people are risk averse. This does not mean, however, they will not take a risk. It means they take a risk only when they expect to be rewarded for taking it. People have different degrees of risk aversion; some are more willing to take a chance than are others.
RISK NEUTRAL: Someone who is indifferent to risk is risk neutral.
RISK SEEKER: Someone who actively seeks out risky situations (a gambler) is a risk seeker.
- For small amounts of money, most people enjoy the thrill of a long-shot wager.
- For more significant sums, though, the tendency to risk aversion is nearly universal.
RETURN: People invest because they hope to get a return from their investment. Return is the good stuff that makes people feel better or improves their standard of living.
RISK: Risk is the bad stuff a risk averse person seeks to avoid. It is a fact of investment life and is unavoidable for anyone who seeks more than a trivial rate of return. Note that risk is a “four letter word.”
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