Risk and return are two important concepts to understand when it comes to investing. Different types of investments have different levels of risk and return, and investors should choose options that match their goals and risk tolerance.
What is risk and return in investing?
When you decide to invest your money, there are two important things to consider: risk and return.
Risk is the uncertainty or variability of the outcome of an investment. In simpler words, it means that there's a chance your investment may not make as much money as you hoped, or you could even lose some or all of your investment.
Return, on the other hand, is the gain or loss from an investment over a period of time. It tells you how much money you made, or lost, on your investment. If you have a positive return, that means your investment has made money. If your return is negative, then you have lost money.
How are risk and return related?
Risk and return are related because generally, the more risk you take with an investment, the higher the potential return. But, taking more risk also means more potential for loss.
Factors that influence risk and return include the type, quality, and duration of the investment, the market conditions, and the investor's behavior. For example, if you invest in a company with a strong track record, your risk might be lower, but so might your return. On the other hand, if you invest in a new company with an unproven track record, you could make a lot of money if the company succeeds, but you also risk losing your entire investment if the company fails.
two arrows, both pointing up. Left arrow reads "risk", right arrow reads "return".
Risk: How can I tell how risky an investment is?
We group investments into three categories: low risk, high risk, and moderate risk and return. It is hard to know how well an investment will do, but there are some general groups we can put them into:
Low-risk, low-return investments: Treasury bills are an example of this type of investment. They are issued by the government and are considered very low-risk, but they also offer lower returns compared to other investments.
High-risk, high-return investments: Penny stocks are an example of this type of investment. These are stocks of small companies that trade at very low prices. They can offer huge returns if the company does well, but they also carry a higher risk of loss.
Moderate-risk, moderate-return investments: Index funds are an example of this type of investment. These are funds that aim to match the performance of a specific market index. They offer diversification and generally have a lower risk than individual stocks, but they can still offer decent returns.
As you can see, we do not have a low-risk, high return (everyone would invest into that) or high-risk, low-return (why would anyone invest into that?). So, remember, risk and return always go hand-in-hand - when one is low, so is the other one, and vice-versa.
| Risk & return | Types of investment |
|---|---|
| Low-risk & low-return | money markets, treasury bills, bonds |
| Moderate-risk & moderate-return | mutual funds, index funds |
| High-risk & high-return | stocks, cryptocurrency, |
Return: Return on investment (ROI)
Imagine you have
Knowing how to calculate ROI can help you decide where to put your money, whether it's a company stock, a business, or even a college savings account. Smart choices today can lead to big rewards tomorrow.
To calculate the return on investment (ROI) for an investment, you can use this simple formula:
For example, if you invested
This means that you made a
Generally speaking, any number that's positive and over
But, also, if you invested
Is this a good return?
A lot of the time, you can find the ROI for different investments online. So, you don't have to do any math. This is helpful when you're trying to decide what to do with your money, like buying stocks or investing in general.
But sometimes, you can't find the ROI on the internet, or you're starting your own business. In that case, it's important to know how to calculate ROI on your own.
Rule of 72
Now that we know what ROI is, we can take investment planning one step further - into the future!
For this, you need the Rule of 72. The Rule of 72 is a simple math formula that helps us estimate how long it will take for our money to double when we invest it. All we have to do is divide the number
For example, if we invest our money and earn an interest rate of
Why is the Rule of 72 useful?
The Rule of 72 is helpful because it shows us the power of investing and how our money can grow over time. When we invest, we want our money to grow and make more money for us. By using this simple rule, we can quickly see how long it will take for our money to double at different interest rates.
How can we use the Rule of 72 with ROI?
Remember, ROI helps us figure out how much money an investment makes. We can use the Rule of 72 together with ROI to see how our money should behave in the future.
For example, imagine you invest
Using the Rule of 72 and the
In
Check your understanding
If you put
Conclusion
In conclusion, investing is one way to grow your money and reach your goals faster. Remember, higher risks often lead to higher returns, but it's important to be smart about it. Keep the Rule of 72 in mind to quickly estimate how long it'll take to double your investment. Next, start learning about investment options and make your money work for you, as you step into the world of financial growth and success.
Log in Leon-Art 9 months agoPosted 9 months ago. Direct link to Leon-Art's post “Why is it 72 specifically...” Why is it 72 specifically and not any other number? • (7 votes) Chase Carnaroli 9 months agoPosted 9 months ago. Direct link to Chase Carnaroli's post “I asked Khanmigo and this...” I asked Khanmigo and this was the response that I got: """ The actual formula for the time it takes to double an investment is: This makes time to double approximately Now remember that interest rates are a decimal (8% -> 0.08). In this example, the time to double would be That's not easy to calculate in your head though! To simplify it, let's multiple the top and bottom by 100. This is a little better but 69.3 is not easy to divide. We'll round up to 72 because that is a much easier number to divide by. So finally we are left with Although not exact, this approximation is usually good enough to determine how long it will take for your investment to double. (12 votes) Izzy 6 months agoPosted 6 months ago. Direct link to Izzy's post “_Dear Fellow Students, ...” Dear Fellow Students, After I watched the video, I scoured the internet about Penny Stocks (I'm a curious 15-year-old... can you blame me?). I saw a chart with different company statistics on it, read into it, and it looked pretty cool. However, while in the midst of my imaginary hunt for something I couldn't quite name, I found something intriguing... I saw that a man named Warren Buffet and his accomplice had gotten in trouble with the Federal government for manipulating the price of penny stocks. My question is How Exactly?? I think that paying more than the average $5 per stock would benefit the business. So can someone please explain this to me? Lots of thanks • (6 votes) connor 7 months agoPosted 7 months ago. Direct link to connor's post “SHould I invest in roblox...” SHould I invest in roblox stock • (5 votes) David Alexander 7 months agoPosted 7 months ago. Direct link to David Alexander's post “Have you checked with you...” Have you checked with your broker? She may be able to check for you on that particular stock and tell you if it's a good idea. (1 vote) Ethan 7 months agoPosted 7 months ago. Direct link to Ethan's post “If penny stocks are high ...” If penny stocks are high risk, does that mean the relative loss is risky? Since they trade at low prices, you wouldn't lose too much if they fail, but will gain a lot if they succeed, why is this considered "high risk"? Is it the idea that what you put in will likely disappear, even though they aren't particularly expensive? • (3 votes) Jake 4 months agoPosted 4 months ago. Direct link to Jake's post “At what age should I begi...” At what age should I begin investing in these financial markets (stocks, bonds, mutual funds, etc.)? Is there a strategy for a "beginner" investor? Are there investments that are better (and less riskier) than in financial markets? • (1 vote) David Alexander 4 months agoPosted 4 months ago. Direct link to David Alexander's post “I'm assuming that you are...” I'm assuming that you are not yet 18 years old, and legally able to invest in your own name. So, either get a trust account where your parents control things for you, or just wait. Whatever your age might be, don't begin investing until you have saved the necessary emergency fund. Even if you are legally entitled to invest, as a "beginner" you should rely on an advisor, who will charge you some money for the advice, but will help you avoid losing the money based on your own inexperience. (3 votes) Preston Howard III 7 months agoPosted 7 months ago. Direct link to Preston Howard III's post “Can you make a lot of mon...” Can you make a lot of money in just one year instead of getting $1,000 every 9 years • (1 vote) David Alexander 7 months agoPosted 7 months ago. Direct link to David Alexander's post “Investments can make a lo...” Investments can make a lot more than that when done wisely. BUT, investments can also lose it all. So don't be greedy, and understand the risks you are taking. (3 votes) lol 2 months agoPosted 2 months ago. Direct link to lol's post “What is index funds and p...” What is index funds and penny stocks? • (1 vote) JamesB 7 months agoPosted 7 months ago. Direct link to JamesB's post “Should I invest now?” Should I invest now? • (1 vote) David Alexander 7 months agoPosted 7 months ago. Direct link to David Alexander's post “You haven't said when "no...” You haven't said when "now" is. Are you 13 or 31? The answer will be different depending on your "now". (1 vote) CeciliaQ 7 months agoPosted 7 months ago. Direct link to CeciliaQ's post “Why is it 72 specifically...” Why is it 72 specifically and not any other number? • (1 vote) David Alexander 7 months agoPosted 7 months ago. Direct link to David Alexander's post “Actuarial science may hav...” Actuarial science may have the answer to that. I'm not an actuary, though. (1 vote) Evelyn Wagener 4 months agoPosted 4 months ago. Direct link to Evelyn Wagener's post “In the "Return on Investm...” In the "Return on Investment" section, in the second paragraph, it says, "whether it's a a company stock". This is a mistake, right? Will it get fixed? • (1 vote) Elvira (Elly) 4 months agoPosted 4 months ago. Direct link to Elvira (Elly)'s post “Thanks, Evelyn. Definitel...” Thanks, Evelyn. Definitely a typo. We are fixing it! (1 vote)Want to join the conversation?
The Rule of 72 is an approximation that comes from the formula for exponential growth.
Time to double = ln(2) / ln(1 + interest rate)ln(2) is approximately equal to 0.693.
For small interest rates, ln(1 + interest rate) is approximately equal to the interest rate itself.
"""0.693 / interest rate. 0.693 / 0.08. 69.3 / 872 / 8 = 9.
- Izzy <3
