More Risk, More Return: Nepali Share Market 2021

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More Risk, More Return: Nepali Share Market 2021

“Risk comes from not knowing what you are doing.”

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– Warren Buffet. 

The way an individual controls risk is at the core of good investing. Gambling is simply a synonym for speculation, and if you utilize guessing as a pillar of your investment strategy, you will surely lose. While investing in stock markets, making an informed decision based on the analysis of an investment option’s systematic and unsystematic risk is important. But, before we get into the discussion of the risk-return relationship, I believe that understanding the concept of risk in financial terms is important.

More Risk, More Return: Nepali Share Market 2021
More Risk, More Return: Nepali Share Market 2021

What is risk?

In financial terms, risk is the difference between an investment’s actual return and the investor’s expected return. The possibility and magnitude of loss are represented by risk, which is linked to the investment product chosen and the investment horizon of an investment. Risk is calculated in the financial industry using standard deviation, a metric that reflects the volatility or fluctuation in the price of an asset when compared to historical averages over a specific time frame.

Types of Risk?

There are some things in this world that you can’t avoid, but there are others where the danger associated with them can be reduced by following the required techniques and steps. The two basic types of investment risks, as well as their sub-divisions, are defined primarily below.

We will not go into depth about each and every sort of risk because it would detract from the purpose of this article, but we will definitely examine the two broad categories of risk, systematic and unsystematic risk.

Systematic Risk

The term “systematic risk” refers to an uncontrollable/market risk that has the ability to disrupt global markets. To a large extent, it is a very unpredictable and unavoidable type of risk. Interest rate changes, inflation, recessions, and wars are examples of systemic risk, as are other major economic, geopolitical.

Unsystematic Risk

Unsystematic risk is a sort of diversifiable investment risk that can be minimized and ideally controlled by correct asset selection and allocation in accordance with current market attitudes. Unsystematic risk includes risks such as a new market participant entering a specific industry, a competitor launching a substitute at a marginal shifting cost, or a customer recalling a sold product due to safety or other major concerns.

What financial ratios can be used to calculate risk-reward trade-offs?

Standard deviation is used to calculate the level of risk associated with an investment product, although it has some limitations, such as showing how annual returns of an investment are spread out rather than validating future performance consistency. We also have two more ratios that might assist you understand the risk of the investment option you’ve picked.

  • Sortino Ratio: It is a financial ratio that provides a true picture of a company’s stock’s downside or negative deviation. It allows you to calculate the amount of return you’ll be able to earn per unit for a certain magnitude of downside risk, commonly known as the probability of avoiding large losses. It’s usually preferable to have a larger sortino ratio.
  • Sharpe Ratio: It’s a financial ratio that takes both upside and negative volatility into account when determining a stock’s performance. Sharpe ratios are a statistical method for predicting risk-adjusted investment returns. A greater Sharpe ratio means a larger potential profit but also a higher risk.

Mid-cap stocks have done excellently in recent years, despite the fact that they carry a high level of risk. There are a number of implications that can be derived from these graphs and tables, but the most important is that great risk does not imply or validate high profits. When risk is taken into account, small cap stocks have the biggest standard deviation, but when risk is taken into account, the return from US mid-size stocks and US large-cap stocks is the highest.

There is no power in the world that can protect you from heavy, enormous, gigantic losses in the future if you invest in the markets and make judgments based on simple assumptions, grapevines, pseudo discussions, and feelings.

More Risk, More Return: Nepali Share Market 2021

Conclusion

The stock market is a mix of speculative risk (the danger of making a profit or losing money) and pure risk (the possibility of loss or no loss only). You should have a mix of risk averse and risk prone investment goods in your portfolio to maximize your profits. In the world of stocks, there is no such thing as a totally risk-free investment; even government-backed treasury securities have a low magnitude risk of default.

To generate a fair level of return with low risk, all you need is a well-balanced portfolio. Risk profiling is an important aspect of risk management and a critical stage in maximizing a portfolio’s returns. Individuals must choose their objectives and the time frame in which they intend to achieve them. We can next choose an asset class that has the ability to generate the desired returns while keeping our risk appetite in mind.

For example- A young person can invest aggressively in stocks and even have a large portion of their portfolio invested in financial instruments that exhibit a high risk-reward trade-off, but a person about to retire should not build their portfolio with small-cap or mid-cap stocks or any other financial instrument that requires a long time horizon to appreciate. The heart of any investment plan is making informed judgments that may then be translated into taking reasonable risk. When you make an investment based on your emotions rather on facts and data that are available to you, risk and return are negatively correlated.

More Risk, More Return: Nepali Share Market 2021

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