Video Transcript: Risk and Reward

Hello, welcome back. In this video, we're going to discuss risk and reward. So,  for every risk that we take on financially, there is a reward for this risk, right? So,  for the greater the risk, the greater reward we're going to want to receive in  return. Okay, so let's look at a $1,000 investment, right. Our investment is the  capital that we are risking, right. So we're putting up our investment of $1,000 in  hopes that we will return some reward based on our amount of risk taken in the  market, so with every investment that we make, there is a certain level of risk  that we may either lose all or part of the investment, right, so we want to run  through some of the different risk mechanisms or investments that we can invest in, right, and talk about their, their risk and reward basis, right. So first we'll look  at an FDIC insured savings account, right. So the Federal Reserve has created  this federal deposit insurance right for all Americans, or anybody that has a  checking account, right, or any account that up to $250,000 The Federal  Reserve and the US Treasury will insure that money up to $250,000 right? So  we have an insured savings account, right? So the risk for that, because it is  insured and we're only risking $1,000 or making that investment, right? It's well  under the $250,000 threshold set forth by the Federal Reserve. Okay, our  reward for taking on that zero risk, because it's zero risk. Why? Because it's  insured by the Federal Reserve. So, therefore, our reward will be very minimal  at 1% Notice our yield on this risk on $1,000 is $1,010 or 1% of $1,000 so very  zero risk, no risk. We get a very minimal return, right? So now let's look at the  next risk investment. So now we want to lend our cash to a reputable company.  Okay, XYZ, they've been in business for 150 years, and they have a very strong  balance sheet, and they're a dominant player in their market, and they have  plenty of market share. So, they're a reputable company, right? So, we're going  to, we want to lend the cash to somebody that we know that can pay us back  right over time. We know that they are going to be able to pay us back, so our  risk is very low, right. So we're going to buy their corporate bonds. We know that they're a reputable company. We know that they're a dominant player in their  space. We know that they have a strong balance sheet, and they're able, they're going to be able to pay us back one way or another, right. So, because the risk  is low, right, but greater than the risk of an FDIC insured savings account, right,  because remember that money is insured, so it's zero risk. Our investment in the low risk firm right is going to yield us 6% Notice it's greater than the FDIC  insured savings account, because the risk is zero. So, because the risk was  zero, we had a 1% yield. Now, because the reputable company has got a little  more risk, right. We are going to yield 6% on our investment. Now, notice, as the risk appetite increases, so does the reward for making that investment and  risking your capital, right? So, the 6% right, is going to yield us $1,060 on our  $1,000 investment. So now let's go look at the next potential investment  opportunity. Okay, so your doctor friend, right, comes to you and says, "Hey, I  need to borrow some money, right. Let me, let me borrow some money, or 

come, or come invest in this opportunity that I have, and I'm trying to diversify  my portfolio, and I'm going to create widgets, and I'm going to sell widgets on  the market, but because I don't want to risk all of my capital, I want to raise a  

little cash, so he looks over next door to you, and he says. Hey, man, invest  $1,000 in my widget company, right? And you say, okay, great, that sounds  good. I'll invest $1,000 in your widget company. You're a smart guy, you're a  

doctor, you can probably sell these widgets too, right? All right, so now what is  the risk of this doctor, right, your partner? Now, what is the risk that he may not  be able to pay you back, right? He's not insured, he's not reputable, right? He  may be a reputable person in the community, but his business idea and his  business production is not reputable, because it's a brand new venture. How are we going to know that this guy's business idea selling widgets is going to  succeed? Right, we're taking a high risk here, right. So now, so let's say the  widget idea falls flat on its face. He doesn't sell any widgets, and I want my  $1,000 back, because he's not selling any widgets, and he's not making any  money, right? But in the meantime, let's say the doctor loses his job, now what,  right? So now the risk is unlimited, right, because he may not be able to pay us  back at all, right, and because you're not investing in a reputable company,  right? The same bankruptcy laws probably will not apply, because he's not an  LLC partner, right? He's, he's a sole proprietor with zero, with all the liability,  right? He's got all the liability, right? So, but he's a doctor, right, and he's got a  good income, so the chances that he loses his job are probably small, right. So,  because the risk is greater than lending to the reputable company, right, buying  their bonds, the reward goes up to 8% now, right, because it's a greater risk  opportunity, right. So I'm going to yield $80 on my $1,000 investment, right,  because I'm research, I'm receiving 8% The risk has increased, so therefore the  reward is increasing. Okay, correlated to the amount of risk, right. So invest in  the stock market. Okay, let's say annual return is guaranteed to us of 10% right? But what's the risk, right? You could lose your whole investment in the stock  market, right? But a lot of times you can, you have the option to sell, even if you  do lose some money, right? But because of the market volatility, we are going to  be looking for a 10% return, because the stock market is more volatile, much  more risky, right? We want a greater return due to the volatility or the price  movements, right, in the stock market. Okay, the price swings is called volatility,  right? As prices move up and down, we are going to want a greater return,  because our liquidity or our cash is in the stock market, which is subject to many different headwinds or risks, right? So we want a greater return for the stock  market. Okay, now for an even greater risk, right, your brother-in-law comes to  you, he's got a money making scheme, right, and he wants you to invest your  $1,000 right, but he's going to give you a 50% return on your $1,000 right, and  ownership stake in the business, but what's the risk? I could lose everything, I  could ruin my relationship, and my family could be in turmoil, right. So that's why

the reward for this risk is much greater, because your brother-in-law has this  idea that we don't know what's going to work. So he says, "I'm going to give you  an ownership stake, and I'm going to give you 50% return if you let me borrow  the money, right? So you need to make decisions on investing based one on  your risk appetite, which means how much risk can I undertake, right? How  much risk am I willing to bear right to receive this reward, or this return, or this  yield right on my money. So now we're going to graph the risk, just to show you  how it kind of works, right? How just on an illustrative example, right? So risk  and reward. Okay, so now vertical axis, horizontal axis, right. So our reward will  be up here. Okay, our risk appetite, our risk level will be on the horizontal axis.  Now notice at 1%, 6%, 8%, 10%, and 50%. Okay, now 1% is here, pretty pretty  low relative risk right now at 6% We'll notice how. The risk is correlated with the  return. Okay, so as our risk increases, our return or our reward will also  increase, so they are positively correlated as the risk increases, so does the  reward. Okay, so as consumers, as investors, as business owners, we need to  understand the correlation between risk and reward. Okay, just because there's  a nice reward, 50% with my brother-in-law's investment opportunity doesn't  mean I'm going to make the 50% You need to weigh your options, balance them  out, understand, make a rational decision as an investor consumer, as any kind  of public entity to maximize your value and to ensure that you secure your initial  investment, and don't give yourself much downside risk opportunity.