The Relationship between Risks and Rate of Returns
The risk and rate of return, as discussed in business, are directly proportional. It means that as the risk increases, the rate of return increases while as the risk declines, the rate of return decreases as well (Christoffersen, 2012). Therefore, an individual willing to invest must take a decision based on both the risk and rate of return analysis to achieve a high return at a lower risk. Investors are likely to prefer investment decisions that yield high rates of return at minimal risks. The term risk defines the capability of acquiring loss below a person’s investigations. On the other hand, the rate of return refers to the rate at which an investor can acquire benefits from an investment. Different forms of risks and rates of return are discussed in business. Examples of risks include the systematic risks, interest rate risks, risks in the market, risks involving the power of purchasing, unsystematic risks, business risks, and financial risks. The types of rates of returns are the interests, dividends, and capital increases.
The risks and rates of return are used to formulate a portfolio that minimizes risks and maximizes the rate of returns. The individual rates of the asset returns and volatility are considered when creating a portfolio in a certain duration. Therefore, an individual must differentiate the numerous asset locations that exist to reduce the risks hence increasing the performance value. The tactic of allocating the assets involves the pricing approaches, focusing on the returns of different asset groups while creating the beneficial portfolios from the expected discrepancies. The benefits obtained from asset allocation are similar to the benefits from the bonds and stocks. In this case, the risks are below the midpoint of the risk the asset portfolios.
Argument for Investment Diversification
An investor needs to classify an investment vehicle when managing a portfolio. Holding different investments protects the portfolio from fluctuations that may occur in the economy. Scholars introduced the gold investment in business since it can protect the investor’s wealth from undergoing the challenges of finances and economic fluctuations (Peylo, 2012). The reaction of assets resembling each other corresponds when initiating change in the economy and financial organizations.
Applying diversification minimizes the investors’ risks in the investment portfolio. For instance, among common vehicle investments like bonds or shares in the company, gold investment should be considered as the choice for the investor to help in diversifying his or her portfolio regarding the investment. The portfolio containing gold investment is robust and easy unlike other methods applied in investment. The gold investment allows hedging inflation in cases of economic fluctuations. It allows the adjustment of the consumer price index in a changing market. The power in purchasing commodities in this type of investment maintains a transforming era. The gold investment is associated with few risks as well. The liquidity risk, which refers to the impossibilities of selling assets due to the unavailability of a buyer when selling in the market, is less. This is due to the increased demand of consumers or the financial organizations. Therefore, using a Modern Portfolio Theory, (MPT) gives the investors the knowledge on how to apply diversification to optimize the portfolio by embracing a gold investment (Peylo, 2012. It is efficient and possesses less number of risks to the investors.
Using Stocks, Bond, Real Estate, Metals, and Global Funds
The stocks, bonds, the real estate, precious metals, and the global funds are examples of assets, which can make up a diversified portfolio to increase the rate of returns hence minimizing the risks (Sa‐Aadu, Shilling & Tiwari, 2010). Considering the stocks, the prices create an impact on the supply of money (Sa‐Aadu, Shilling & Tiwari, 2010). The use of money excessively increases the demands for the bonds while the rate of returns decreases. Considering that the individual investors alter the market on capital to an equity market, it causes the increase in the stock prices. This method helps to avoid risks in the portfolios. The real estate investment method involves the immovable assets such as lands and buildings. The real estate risk management technique is unique since it involves a group of investors. It allows sharing of the risks incurred and each investor acquires interests in his or her investment. The method of sharing risks decreases the risk burden that initially would be carried by one person. An individual using real estate sets rights and controls them. The real estate study verifies Brown’s work, who initiated the investigation on real estate.
Precious metals such as gold are used in short-term investments. For instance, gold is used in creating a diversified portfolio since its prices are stable and fluctuate rarely (Sa‐Aadu, Shilling & Tiwari, 2010). In Malaysia, Bank Negara invested in gold using the Kijang Emas Bullion Coins in 2001 (Sa‐Aadu, Shilling & Tiwari, 2010). The price of gold can fluctuate in a short time but its value is maintained in a long time. Therefore, gold is essential in a diversified portfolio since its price depends on activities that take place when investing the stocks and bonds. The global funds are used in the diversified portfolio since they assist an individual in investing in his or her insecurities that may be termed to have low value by taking positions in the short term.
The Concept of Efficient Frontier
The concept of the efficient frontier exists in the modern portfolio and involves the portfolios in investments, which occupy the efficient portions of the risks and rate of return system. It simply states that different mixtures of insecurities offer different return rates (Michaud & Michaud, 2008). When calculating the efficient frontier, investors are assumed to have the ability of borrowing and lending at a rate of interest without risks in a short-term position. Hence, they compare between frontier efficiency and the market portfolios during diversification. However, diversification in the developing countries is efficiently ready.
Therefore, an investor is advised to use an efficient frontier when choosing the asset portfolios that he or she can invest. He or she could do so by linking the portfolios having a zero association, which minimizes the variance of the portfolio. For instance, the similar stocks and product futures are fit to use since they have a zero correlation.
Economic Outlook
Having an outlook of the next year in the U.S. economy, investors are encouraged to increase the rate of investment. The evaluation of the assets and monetary policies in the United States of America are expected to diverge. The investors are required to change their attitudes towards investment to achieve the divergence. A low consistency in the correlation of bonds and stocks is expected in future. The movements noted in the currency will determine the portfolio results. Investors must take market liquidity seriously to reduce the possible risks. However, a number of factors would cause deflation in the United States’ economy. The economy is expected to operate at full employment by reducing the gap between the employed and unemployed individuals. In addition, the production levels are expected to improve. However, the United States has the obligation to choose the best portfolio to use. In this case, the portfolio should minimize the risks and increase the rates of returns in the future.
There are two types of portfolios, the short-term, and the long-term portfolios. Although there are many ways of investment, the investment in the short term, the long run, are most studied in business. A long-term portfolio is based on the investment of capital in a long period. It also involves making decisions in a long-term dimension. However, the short-term portfolio aims at increasing the income acquired hence preserving the capital. It allows a short-term investment of money after which it matures at fixed income rates. It allows the generation of excess rates of returns as well.
The United States economy should embrace the short-term portfolios to invest its money in a short time after which it matures. The United States investors will achieve high-interest rates in the money invested and earn returns in a short duration, unlike when using the long-term portfolios (Ross, Westerfield & Jordan, 2008). For instance, if an individual intends to purchase a house, the returns earned on short-term investment would be used as the down payment. If the economy adapts a short-term portfolio, the risks are likely to reduce. Therefore, a short-term portfolio will fit individuals, who need a lot of income in the future, just as the United State needs the portfolio to develop its economy. A short-term portfolio would allow the country to reduce the number of risks, and maximize the rate of returns.
References
Christoffersen, P. F. (2012). Elements of financial risk management. Academic Press.
Peylo B. T. (2012). A synthesis of modern portfolio theory and sustainable investment. The Journal of Investing, 21(4), 33-46.
Sa‐Aadu, J., Shilling, J., & Tiwari, A. (2010). On the Portfolio Properties of Real Estate in Good Times and Bad Times1. Real Estate Economics, 38(3), 529-565.
Michaud, R. O., & Michaud, R. O. (2008). Efficient asset management: a practical guide to stock portfolio optimization and asset allocation. Oxford University Press.
Ross, S. A., Westerfield, R., & Jordan, B. D. (2008). Fundamentals of corporate finance. Tata McGraw-Hill Education.
