The objective of an investor is to obtain the largest possible rate of return without placing invested funds at more risk than is bearable.

The reluctance to assume risk limits your ability to maximize returns. Investors should not assume the risk of greater loss than they can afford. The basic idea -- maximizes return and minimizes risk.  

Investors are looking for a return. Just what is a return on and investment? I think you should know. 

Return = Money You Get

The rate of return is the most important outcome from any investment. Both the gain in an assets value over time (the capital gain) and the monies received while holding an asset (the cash dividend) is of interest to any investor. If you add the cash you receive in hand (like interest payments and dividends) together with any capital gain and divide it by the purchase price, you then know the true return on your money.

Capital Gain (or loss)
+     Cash Dividend / Purchase Price

So, is this really all about getting a return? Then, what is wrong with that you might ask? Nothing at all it seem. But, the amount of return is base on the measure of risk. The higher the risk the great the return or the lower the risk the lower the return. Most people are averse to risk giving it the name, risk-aversion. For instance, when you buy a publicly traded stock, you could loose your entire investment.

On the other hand, if you didn't invest in the stock market during certain periods of history, you would have forgone huge profits. That is called profit-aversion. To be totally risk-averse or totally risk-tolerant does not appear to be the best investment strategy. So, what we are looking for is a sane approach to risk management.



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Assets having a greater probability of loss are felt as "more risky" than those with a lesser chance of loss. The trick is getting the greatest rate of return with the least amount of risk. A common approach to evaluating the risk of an asset involves estimating the pessimistic (worst), the most likely (expected), and the optimistic (best) return associated with a given asset. If you take a group of investments and plot the estimated risk against the return, it usually looks like this – RISK
Well we looked at returns on investment as well as the risk associated with investing and the one key is… Why they say you should never put your eggs into one basket.


In order to reduce overall risk (the steepness of the above graph) it is best to acquire, or add to the existing portfolio, assets that are not related. The technical term for this is not putting all your eggs in one basket. That way if you trip, you won't break all the eggs.

Now let's translate that over to your money:
The creation of a portfolio by combining two assets that behave exactly the same way cannot reduce the portfolio's overall risk below the risk of the least risky asset. (Here comes the important part) The creation of a portfolio by combining two or more assets that behave exactly opposite can reduce the portfolio's total risk to a level below that of either asset alone -- which in certain situations may be zero.

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