Why do people take risk? For bungee jumpers: just to feel alive, by feeling close to death. For investors: because big profits come with big risks (when they do well). The more you can stand to risk, the more you can stand to make...or lose.
A risk curve shows the tradeoffs between taking on risk and assets. Think of investment returns, or whatever payoff value, on the y-axis. The x-axis is cumulative probability of risk—basically, a scale between 0% and 100% of risk. The greater the risk, the greater the average returns could be, so the risk curve slopes upward. You could get a low-risk, short-term bond, which would curve toward the bottom-left: low risk = low gains. Or you could buy some shares of a risky startup, which would be high and to the right: high risk = high potential gains.
The risk curves lives in the home of Modern Portfolio Theory (MPT), which aims to maximize returns while minimizing risk. MPT relies on the risk curve to show investors potential benefits across the efficient frontier, getting the most bang for your buck.
Risk curves are hard to make accurately, since we’re only speculating on how risky something is. We don’t actually know if it was risky or not until something happens...or doesn’t. Historical standard deviation helps figure out what a reasonable assumption of risk could be for a given investment though.
Related or Semi-related Video
Finance: What are Systematic and Unsyste...14 Views
finance a la shmoop what are systemic and unsystematic risk systemic risks are
just endemic to the market want to invest in the stock market and compound [Plate of vegetable appear]
return your way into great wealth great but then you'll suffer the normal risk
of the system that risk specifically is this yeah best of times worst of times
but up over time the market goes up you just have to embrace the notion that [Man hugging a tree]
there is systemic risk in that in the short run you can buy an S&P 500 index
fund here then lose like a third or whatever of your money in not too many
years but if you don't panic and sell just at the wrong time here right out
the storm and keep going well then you should be just fine by the time you
arrive here so that's risk that is always in the system equities rise and [Equity in the ocean]
fall like the tides or something like that but generally they rise and if you
want to swim in this bathtub well you get used to the turbulence and have an [Girl swimming against the tide]
airsick bag handy all right that systemic risk or systemic risk
what's unsystematic risk well it's bad investors or rather bad investing it's
panicking and selling your stock just when you should be doubling down its
buying lousy companies thinking that they're cheap today but not realizing [Woman runs away from smelly girl]
that they will always be cheap because they're lousy or in a lousy industry or
run by lousy management it's buying into lousy industries that also look cheap
but are dying hello paper and pulp is yeah anyone really think that's gonna be [Paper printing]
around in 20 years all right well it's believing the dreamy hopes and prayers
of future earnings and trusting that there really will be 5 million [Traffic on the highway]
driverless cars on the road in 3 years you know good luck with that we'd love
it to be true but ain't gonna be unsystematic risk is also investing in
bonds for the long-term taking very little risk when taking little risk is
the opposite of what you should be doing when you're a young investor so yeah
systematic and unsystematic risk both exist plentifully and both can bite you [Dog bites portfolio from woman]
right in the portfolio so you got to know what both are and embrace them
for what they're worth
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