Concept of Risk and Return in Investment Management

Concept of Risk and Return in Investment

Investment management is a game of money in which we have to balance the risk and return.

Image Credits © Kees van Duyn.

The risks associated with investment are:-

1. Inflation risk : Due to inflation, the purchasing power of money gets reduced.
2. Interest rate risk : Due to an economic situation prevailing in the country, the interest rate may change.
3. Default risk : The risk of not getting investment back. That is, the principal amount invested and / or interest.
4. Business risk : The risk of depression and other uncertainties of business.
5. Socio-political risk : The risk of changes in government, government policies, social attitudes, etc.

The returns on investment usually come in the following forms:-

1. The safety of the principal amount invested.
2. Regular and timely payment of interest or dividend.
3. Liquidity of investment. This facilitates premature encashment, loan facilities, marketability of investment, etc.
4. Chances of capital appreciation, where the market price of the investment is higher, due to issue of bonus shares, right issue at a lower premium, etc.
5. Problem-free transactions like easy buying and selling of the investment, encashment of interest or dividend warrants, etc.

The simple rule of investment management is that:-

1. The higher the risk, the greater will be the returns.
2. Similarly, lesser the risk, the lower will be the returns.

This rule of investment management is depicted in the following diagram:-

The above diagram showing risk and return indicates that:-

1. Low risk instruments such as small savings, and bank deposits bring low returns.
2. Medium risk instruments such as company deposits and non-convertible debentures will earn medium returns.
3. High-risk securities like equity shares, and convertible debentures will earn higher returns.