Risk vs. Reward

Let's explore Risk vs. Reward: the most important relationship in investing! 📉📈

Risk = how much you can potentially lose on an investment.

Let’s say you invest $10 in Disney stock.

You’ve risked $10, since if Disney goes out of business you’d lose $10.

On the other hand, if Disney stock doubles in value, then your $10 investment will be worth $20. 😁

In this case, your reward would be $10 (since you’ve gained $10).

But how should you decide whether to invest in Disney or not? 🤔

Well, it depends on what you think is more likely to happen: the stock doubling, or the company going out of business.

If you think it’s more likely that the stock doubles, then Disney might be a good investment because you are more likely to earn $10 than you are to lose $10. ⚖️

In other words, your potential reward is higher than your potential risk.

If you’re comfortable with probabilities: imagine there’s a 90% chance that Disney stock doubles, and only a 10% chance that it goes out of business.

Now calculate your potential risk & reward -- you can see why Disney would be a great investment!

It’s important to understand that you can directly control how much risk you take on, by deciding:

1️⃣ how much money to invest

2️⃣ what you invest in

The more money you invest, the more you’re risking. 💸

For example, if you invested $100 instead of $10 in Disney, your potential risk is 10x bigger – but your potential reward is 10x bigger as well.

And by picking what to invest in, you can control your risk as well because some stocks are more likely to lose your money than others; they have “higher risk”. 🚨

In general, higher risk stocks also have higher potential rewards, while lower risk, or “safer” stocks typically have lower potential rewards.

As an investor, your goal is to pick a set of investments that gives you the highest potential reward and lowest potential risk. 📝

In the next lesson, you'll learn the most important technique to achieve this: diversification.

Test your knowledge

What is risk?

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What is reward?

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As an investor, what’s your primary goal in regard to risk and reward?

Choose an option

What's next?

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