Investments: Analysis and Management, 12th Edition

chapter 6

The Returns and Risks from Investing

As you continue to prepare yourself to put together and manage a $1 million portfolio, you realize you need to have a very clear understanding of risk and return. After all, as you recall from your introductory finance class, these are the basic parameters of all investing decisions. While you agree that the past is not a sure predictor of the future, it seems reasonable that knowing the history of the returns and risks on the major financial assets will be useful. After all, if stocks in general have never returned more than about 10 percent on average, does it make sense for you to think of earning 15 or 20 percent annually on a regular basis? And what about compounding, supposedly an important part of long-term investing? How much, realistically, can you expect your portfolio to grow over time? Finally, exactly what does it mean to talk about the risk of stocks? How can you put stock risk into perspective? If stocks are really as risky as people say, maybe they should be only a small part of your portfolio.

Although math is not your long suit, you realize that it is not unreasonable that a $1 million gift should impose a little burden on you. Therefore, you resolve to get out your financial calculator and go to work on return and risk concepts, knowing that with some basic understanding of the concepts you can take the easy way out and let your computer spreadsheet program do the hard work.

Chapter 6 analyzes the returns and risks ...