Page 164

165

Step 8: Riskese

returns, investors would be better served to be more concerned with the risk level of their investments. The overall concept of the risk/return relationship is that when risk increases, the expected return on the asset should also increase as a result of an expected risk premium.

solutIons rIsk defIned Modern finance began with the realization that risk needed to be measured and managed. In 1654, French mathematicians Blaise Pascal and Pierre de Fermat tried to predict the future outcome of a game of chance. Their questions led to Pascal’s Theory of Probability, which Blaise Pascal quantifies the numerical likelihood of future events. Pascal’s Triangle was the foundation for learning how to manage the uncertainty of future outcomes, such as investment returns. Every investment carries an expected return. The risk of an investment is quantified by the degree to which the returns of the investment deviate from the average return during specific periods of time. Higher risk investments carry a wider range of short-term outcomes but also carry higher expected returns, compensating investors for withstanding short-term volatility. In contrast, investments that have had a narrow range of outcomes over long periods of time are expected to provide more consistent returns with the trade-off of lower returns.

Index Funds: The 12-Step Recovery Program for Active Investors  

This book reveals the potential land mines and pitfalls of active investing and educates readers on the benefits of passive investing with i...

Index Funds: The 12-Step Recovery Program for Active Investors  

This book reveals the potential land mines and pitfalls of active investing and educates readers on the benefits of passive investing with i...