What is the Risk-Reward Matrix?
If you have seen the recent miniseries about one of India’s famous scammers, you would have come across this phrase: Risk hai to Ishq hai (Where there is a risk, there is love) Think about the times that you enjoy going on a long drive. When you started learning how to drive, it must have seemed risky and scary. But now that you are an experienced and good driver, you can enjoy the road to a great extent. All that risk you took seems to be worth it, right? The same is true for investment. Every investment has some level of risk. While you cannot prevent risk, you can reduce it by being financially savvy and recognising your risk tolerance. The same is true for investment. Every investment has some level of risk. While you cannot prevent risk, you can reduce it by being financially savvy and recognising your risk tolerance. So, if you want to achieve your goals, you must invest. But, if no investment is genuinely risk-free, how will you achieve your objectives? That's a problem! But there is a workaround. You can increase your return potential by diversifying into the correct investments to help limit market volatility and keep your financial goals on track. Investment risk-reward matrix Every investor seeks an investment opportunity that will provide them with the highest possible profits as quickly as possible. But remember that it's better to proceed slowly in the correct way than quickly in the wrong direction. And, as the saying goes, "all good things take time." Similarly, investments take time to mature. In terms of investments, the risk-to-reward ratio is an important issue to consider. Consider you and your friend deciding to participate in the 'dice throwing' Instagram trend. In this game, your friend suggests that each of you contribute Rs. 500, for a total contribution of Rs. 1000. You will win the complete money if the dice is tossed and lands on an even number. Your friend stands to win if it is an odd number. The risk to reward ratio, in this case, is 1:1, as both of you have a 50% chance of winning the money you put in. It doesn't sound like an attractive investment, does it? Assume you opted not to play. Your friend decides to up the stakes after hearing this. He modifies the game and recommends that if you contribute 500, he would place three times that amount, or 1500, for the same bargain. This sounds amazing, doesn't it? You still have a half-chance of winning. If you win, he will receive Rs. 1500, which is three times your initial investment. As a result, the risk to reward ratio is 1:3. In technical terms, the risk to reward ratio is a valuable measure that helps gauge an investment's profit (reward) relative to its potential loss (risk). We have already learned that each investment carries a certain level of risk. According to the industry, the greater the risk, the greater the reward. We'll look at common assets and their risk-reward ratios to see what you may expect if you invest in them. Equity Shares and equities are the most volatile of all investments, making them the riskiest. However, it has the greatest potential for long-term profitability. Debt/bonds Debt securities are issued with the promise of interest payment. Because the risk is lower, the rewards achieved over time may not be as great as in the case of equities. Property investment The real estate market is volatile by nature. Key risks are determined by a variety of factors such as geography, demand, structural challenges, and a lack of liquidity. Based on all of these criteria, the risks associated with real estate investing are likely to be comparable to those associated with equities and bonds. Gold When it comes to gold investment risks, the expense of keeping and insuring the precious metal may be included. However, you can now invest in gold through Sovereign Gold Bonds (SGB), digital gold, gold ETFs, and gold mutual funds. Investing in gold provides diversification and a distinct blend of reward benefits. However, the risks associated with commodities such as gold are determined by market demand and supply. Varied assets will provide you with different growth rates. After reading about the various degrees of risk associated with each investment, you may be wondering, what if you just keep the money at home? Wouldn't that imply no risk? Keeping cash at home, for example, may be dangerous. Alternatively, simply having money in a savings account exposes it to inflation. This means that the money will continue to lose value over time. And that's an extra risk you'd be incurring. So, it is always better to invest.