ALL investments involve some risk because the future value of an investment is never certain. Risk, simply stated, is the possibility that the ACTUAL return on an investment will vary from the EXPECTED return or that the initial principal will decline in value. Risk implies the possibility of loss on your investment.
Factors which affect the risk level of an investment include:
- Business failure
- Changes in the economy
- Interest rate changes
The Risk / Return Relationship
Generally speaking, risk and rate of return are directly related. As the risk level of an investment increases, the potential return usually increases as well. The pyramid of investment risk (Figure 2) illustrates the risk and return associated with various types of investment options. As investors move up the pyramid, they incur a greater risk of loss of principal along with the potential for higher returns.