{"id":498,"date":"2023-12-19T19:35:25","date_gmt":"2023-12-19T19:35:25","guid":{"rendered":"https:\/\/pressbooks.ccconline.org\/accinvestments\/?post_type=chapter&#038;p=498"},"modified":"2023-12-19T19:35:25","modified_gmt":"2023-12-19T19:35:25","slug":"1-4-risk-versus-return-%e2%80%92-the-eternal-struggle-of-investing","status":"publish","type":"chapter","link":"https:\/\/pressbooks.ccconline.org\/accinvestments\/chapter\/1-4-risk-versus-return-%e2%80%92-the-eternal-struggle-of-investing\/","title":{"raw":"1.4: Risk versus Return \u2012 The Eternal Struggle of Investing","rendered":"1.4: Risk versus Return \u2012 The Eternal Struggle of Investing"},"content":{"raw":"<section class=\"mt-content-container\">\r\n<p class=\"lt-biz-79465\"><iframe id=\"iFrameResizer0\" title=\"Chapter 01 - Slides 35-54 - Risk versus Return\" src=\"https:\/\/wonderprofessor.com\/123\/Chap01\/Chap01_Slides_35_to_53\/Chap01_Slides_35_to_53.html\" width=\"640\" height=\"480\" allowfullscreen=\"allowfullscreen\" data-mce-fragment=\"1\"><\/iframe><\/p>\r\n<p class=\"lt-biz-79465\">Here it is, Dear Readers! This is the entire course in one section! Do you want to eat well or do you want to sleep well? By now, you should be seeing that there is a pattern in the world of investments. The more return you want from your investments, the more\u00a0risk\u00a0you will have to accept. In the previous section, we saw that stocks have given us the best returns over time but have also subjected us to the most\u00a0risk. Bonds are less risky but give us less return.\u00a0Short-term\u00a0investments are\u00a0risk\u00a0free or pretty darned close but they pay very little. Mutual funds will more or less reflect the underlying assets that they invest in. In the corresponding presentation on\u00a0risk\u00a0versus return, you will see how these various\u00a0investment\u00a0asset classes have done over very long periods of time. We see that stocks are the stars! Bonds are a distant second. And\u00a0short-term\u00a0investments have barely kept up with inflation and currently are losing to inflation. Take a quick look at this graph that compares stocks (businesses), bonds (loans), Treasury bills (short-term\u00a0guaranteed investments), and inflation as measured by the Consumer Price Index.<\/p>\r\n<p class=\"lt-biz-79465\"><img class=\"internal\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/41151\/1928_2022_Stocks_Bonds_Cash_CPI_Logarithmic_With_Warning.png?revision=1&amp;size=bestfit&amp;width=735&amp;height=471\" alt=\"The Growth of $1 in Stocks, Bonds, &quot;Cash,&quot; and Inflation. Returns from 1928 to 2022. Warning: Logarithmic Scale!\" width=\"735px\" height=\"471px\" \/><\/p>\r\n<p class=\"lt-biz-79465\">Source:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\"><u>NYU Stern School of Business<\/u><\/a>,\u00a0<a class=\"link-https\" href=\"https:\/\/www.minneapolisfed.org\/about-us\/monetary-policy\/inflation-calculator\/consumer-price-index-1913-\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Federal Reserve Bank of Minneapolis<\/u><\/a><\/p>\r\n<p class=\"lt-biz-79465\">We see that the rewards from investing in businesses via stocks have completely overwhelmed the two other choices and have handily beaten inflation. However, what is different about this graph than most graphs we are used to viewing? What is this graph hiding? In this graph and many graphs in the world of investing, we use a logarithmic scale. In the opinion of Your Humble Author, all graphs using a logarithmic scale should have warning labels attached to them since most individuals don\u2019t completely understand how they work. Each unit on the left is 10 times bigger than the previous unit. Logarithmic graphs are used when the numbers grow exponentially. The graph is hiding the enormous difference between stocks on the one hand and bonds, Treasury bills, and inflation on the other. It is also minimizing the large downturns that stocks experience from time to time. Here is an arithmetic version of the same graph:<\/p>\r\n<p class=\"lt-biz-79465\"><img class=\"internal\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/41152\/1928_2022_Stocks_Bonds_Cash_CPI_Arithmetic.png?revision=1&amp;size=bestfit&amp;width=719&amp;height=517\" alt=\"The Growth of $1 in Stocks, Bonds, &quot;Cash,&quot; and Inflation. Returns from 1928 to 2022. Arithmetic Scale.\" width=\"719px\" height=\"517px\" \/><\/p>\r\n<p class=\"lt-biz-79465\">Do you see why we initially used a logarithmic scale? Because of the enormous differences in results, the bonds,\u00a0Treasury bill, and inflation don\u2019t even begin to show any rise in value in the arithmetic graph. Around 1988, the arithmetic graph also begins to show us the exponential curve that stocks exhibit. It also highlights that what we thought were little rises and falls in the price of stocks are actually very dramatic. Stocks are volatile!\r\n\r\nWhat happens if we go back to the dawn of the Industrial Revolution?<\/p>\r\n<p class=\"lt-biz-79465\"><img class=\"internal\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/41153\/1801-2022-Returns_Massaged.png?revision=1&amp;size=bestfit&amp;width=698&amp;height=476\" alt=\"The Growth of $1 Since the Dawn of the Industrial Revolution. Returns of stocks, bonds, &quot;cash&quot; investments, gold, and inflation, 1801 to 2022.\" width=\"698px\" height=\"476px\" \/><\/p>\r\n<p class=\"lt-biz-79465\">The numbers become staggering and we are left with a few takeaways. Bonds and \"cash\" investments have done admirably; they have beaten inflation. Gold? Not so much. However, stocks are the hands-down best choice, right? Well, yes, but again, let's not be too hasty. We need to look at the other side of investing,\u00a0risk, as well as the return. We will examine in detail the risks involved with\u00a0stock\u00a0investing soon.It is no accident that stocks and bonds have produced better returns than\u00a0short-term\u00a0investments. If that were not the case, why would investors assume the higher risks of stocks and bonds? The answer is they would not. If guaranteed (or pretty darned close to being guaranteed)\u00a0short-term\u00a0investments returned the same as stocks or bonds, investors would prefer those guaranteed\u00a0short-term\u00a0investments. They would choose an\u00a0investment\u00a0for which there is no chance of losing money and they would be happy to accept the\u00a0<u><\/u>risk-free rate of return<u><\/u>\u00a0on their money. In theory, there is no\u00a0investment\u00a0with absolute zero\u00a0risk. However,\u00a0short-term\u00a0United States Treasury bills come as close to absolute zero\u00a0risk\u00a0as you can get in this world. Therefore, when investors want to know what the current\u00a0risk-free rate of return\u00a0is, they often look at the\u00a0interest\u00a0rate that three-month United States Treasury Bills are currently paying. (We will cover Treasury Bills in more detail in our next section dedicated to\u00a0short-term\u00a0investments.)To make prudent<\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">investment\u00a0decisions, we investors need to know what the\u00a0<u><\/u>risk<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/r\/riskpremium.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>\u00a0premium<\/u><\/a>\u00a0is for our potential investors. The\u00a0risk\u00a0premium is the reward for bearing\u00a0risk. It is the extra return on a risky asset over the return that we receive from a\u00a0risk-free rate of return. As we would expect, the\u00a0risk\u00a0premium for stocks is the highest at over 8%. The\u00a0risk\u00a0premium for large company bonds is a bit less than 4% and less than 2% for government bonds. Here are the\u00a0risk\u00a0premiums for large company stocks, large company bonds, government bonds, and Treasury bills (guaranteed\u00a0short-term\" cash\" investments).<\/div>\r\n<table class=\"mt-responsive-table\" summary=\"Investment Risk Premiums from 1928 to 2022\"><caption>Investment Risk Premiums from 1928 to 2022<\/caption><colgroup><col width=\"160\" \/><col width=\"174\" \/><col width=\"175\" \/><\/colgroup>\r\n<thead>\r\n<tr>\r\n<th class=\"mt-align-center\" scope=\"col\">Investment<\/th>\r\n<th class=\"mt-align-center\" scope=\"col\">Average Return<\/th>\r\n<th class=\"mt-align-center\" scope=\"col\">Risk Premium<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Large Company Stocks<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">11.51%<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">8.17%<\/td>\r\n<\/tr>\r\n<tr>\r\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Large Company Bonds<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">6.99%<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">3.62%<\/td>\r\n<\/tr>\r\n<tr>\r\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Government Bonds<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">4.87%<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">1.53%<\/td>\r\n<\/tr>\r\n<tr>\r\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Treasury Bills (\"Cash\")<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">3.34%<\/td>\r\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">0.00%<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<p class=\"lt-biz-79465\">Source:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\"><u>NYU Stern School of Business<\/u><\/a>,\u00a0<a class=\"link-https\" href=\"https:\/\/www.minneapolisfed.org\/about-us\/monetary-policy\/inflation-calculator\/consumer-price-index-1913-\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Federal Reserve Bank of Minneapolis<\/u><\/a><\/p>\r\n<p class=\"lt-biz-79465\">These\u00a0risk\u00a0premiums may not seem like much but over time, the effects of the higher returns are enormous as we saw in the graphics above and in the presentation.\u00a0Investment\u00a0returns are very easy to measure. How much did you start with? How much did you end with? How long did it take you to earn this amount? From this information, we can calculate your return. But what about the risks involved. How do we measure\u00a0risk?<\/p>\r\n\r\n<div id=\"section_1\" class=\"mt-section\"><span id=\"Variance_and_Standard_Deviation_.E2.80.92_Two_Imperfect_Measures_of_Risk\"><\/span>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><\/div>\r\n<h2 class=\"lt-biz-79465 editable\">Variance and Standard Deviation\u2012 Two Imperfect Measures of Risk<\/h2>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">Investment risk, on the other hand, is much more difficult to measure. The reality is that\u00a0risk\u00a0is impossible to measure and predict. There is no measurement that accurately reflects the amount of\u00a0risk\u00a0that investors must accept when choosing an\u00a0investment. That does not stop us from trying, though. Each year, the\u00a0investment\u00a0community measures the average annual return and the amount of\u00a0variance\u00a0from the average return. Using statistics, the resulting measures of\u00a0risk\u00a0are called\u00a0<u><\/u>variance<u><\/u>\u00a0and\u00a0<u><\/u>standard deviation<u><\/u>. By far, the most popular measure of\u00a0risk\u00a0is\u00a0standard deviation.\u00a0Standard deviation is the measure we will use for our class. I already know what you are thinking. \u201c<em>Aye, this is math! I need to drop this class!<\/em>\u201d Relax. Please don\u2019t drop the class. We don\u2019t do any\u00a0variance\u00a0or\u00a0standard deviation\u00a0calculations. We leave those calculations for your statistics class. We just do a quick library or Internet search and the\u00a0investment\u00a0community readily and happily gives us the results. Please. Don\u2019t drop the class. Keep reading.<\/div>\r\n<div aria-expanded=\"false\"><\/div>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">It is important to understand what the\u00a0variance\u00a0and its more popular and important companion,\u00a0standard deviation, can tell us about a potential\u00a0investment. In general,\u00a0<strong>the higher the\u00a0<\/strong><\/div>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">variance<strong>\u00a0and\u00a0<\/strong>standard deviation<strong>, the riskier the\u00a0<\/strong>investment<strong>.<\/strong>\u00a0The higher the\u00a0variance and\u00a0standard deviation, the more the\u00a0investment\u00a0return will deviate from the average annual return of that\u00a0investment. In other words, we said that stocks can give us an average annual return of 8%, 9% or even 10% over the long term but we also know that in any one year, the probability is very high that we won\u2019t get 8% or 9% or 10%. We might get +17% in one year, -9% the next year, +22% after that, and then -4%. With stocks, the variances and deviations from the annual returns are extreme. A high\u00a0standard deviation\u00a0means the\u00a0volatility\u00a0is high. The\u00a0investment\u00a0is risky.<\/div>\r\n<div aria-expanded=\"false\"><\/div>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">Please take a close look at the following frequency distribution graph:<\/div>\r\n<p class=\"lt-biz-79465\"><img class=\"internal default\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/45786\/NormalDistribution_2022_Book.jpg?revision=1&amp;size=bestfit&amp;width=769&amp;height=433\" alt=\"The normal distribution, also known as the normal curve or the bell curve. Stock market returns tend to follow the normal distribution.\" width=\"769px\" height=\"433px\" \/><\/p>\r\n<p class=\"lt-biz-79465\">Source:\u00a0<a class=\"external\" title=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\">NYU Stern School of Business<\/a><\/p>\r\nHow do we interpret this graph? This graph shows us the annual returns from the\u00a0stock\u00a0market for every year from 1926 until 2022. Each year is placed in the column that corresponds to the return for that year. For example, in 2020, the return from the\u00a0stock\u00a0market was between 10% and 20%. In 2015, the return was between 0% and 10%. In 2018, the return was between -10% and 0%.\r\n<p class=\"lt-biz-79465\">From the graph, we see that stocks are similar to Henry Longfellow\u2019s little girl with the little curl right in the middle of her forehead. When she was good, she was very, very good, but when she was bad, she was horrid. \u201c<em>Minus 20% in 2001 and 2022, minus 30% in 2002, minus 40% in 2008!? No way! Not for me! I ain\u2019t gettin\u2019 involved in investing in stocks,<\/em>\u201d is how some people react. Relax. Calm down. We are going to learn how to use this\u00a0volatility\u00a0to our advantage. We can make\u00a0volatility\u00a0our friend, not our enemy.<\/p>\r\nAlso, does the\u00a0distribution graph above resemble anything that you are familiar with? Why yes, you may remember it as the normal curve, also known as the normal distribution or the bell curve. Here it is in all its mathematical glory:\r\n<p class=\"lt-biz-79465\"><img class=\"internal default\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/45787\/NormalDistribution_Ferran_Mathematical.png?revision=1&amp;size=bestfit&amp;width=860&amp;height=490\" alt=\"The normal distribution, also known as the normal curve or the bell curve. Stock market returns tend to follow the normal distribution.\" width=\"860px\" height=\"490px\" \/><\/p>\r\nSource:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\">NYU Stern School of Business<\/a>\u00a0; Graphics courtesy of Ferran Capo:\u00a0<a class=\"external\" href=\"http:\/\/www.ferrancapo.com\/\" target=\"_blank\" rel=\"external noopener nofollow\">StudioCapo<\/a>\r\n\r\nIf you are allergic to all things mathematical, please feel free to ignore the above graphic and just read on. What this graph is trying to show us is that the returns from the\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">stock\u00a0market tend to clump around the average return for the past century. What the graph is also telling us is that the probability that we will actually get that market average is quite low. We can\u2019t know what the return will be next year but history tells us there is about a two-thirds chance that the return will be between \u20118.0% and 31.0%. There is a 95% probability that the return will be between \u201127.5% and 50.5%. And there is a better than 99% chance that the return will be between \u201147.0% and 70.0%.<\/div>\r\nHere is another view of\u00a0risk\u00a0versus return:\r\n\r\n<img class=\"internal default\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/45788\/Investments_Returns_and_Standard_Deviations.png?revision=1&amp;size=bestfit&amp;width=844&amp;height=225\" alt=\"The greater the average annual return, the greater the standard deviation and the riskier the investment.\" width=\"844px\" height=\"225px\" \/>\r\n\r\nSource:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\">NYU Stern School of Business<\/a>,\u00a0<a class=\"link-https\" href=\"https:\/\/www.minneapolisfed.org\/about-us\/monetary-policy\/inflation-calculator\/consumer-price-index-1913-\" target=\"_blank\" rel=\"external noopener nofollow\">Federal Reserve Bank of Minneapolis<\/a>\r\n\r\nIf we start with Treasury Bills, the least risky\u00a0investment, and work our way up to stocks, we see the average annual return rise but we also see the\u00a0standard deviation\u00a0rise. It is a bit interesting that the corporate bonds gave us more return while actually having a bit less\u00a0volatility.\r\n<p class=\"lt-biz-79465\"><i>\u201cSo, does you\u2019se got\u2019s it yet? You\u2019se wants\u00a0<b>high returns<\/b>? You\u2019se gonna\u2019 gets\u00a0<b>high\u00a0<\/b><\/i><strong>risk<\/strong><i><b><\/b>! You\u2019se gonna\u2019 lose some money, maybe a lot o\u2019 money! And if\u2019n anybodies tells you\u2019se differently, de\u2019re lying!\u201d<\/i><\/p>\r\n<p class=\"lt-biz-79465\">The lessons from history are that if we want high average annual returns, we are going to have to accept high\u00a0risk\u00a0and high\u00a0volatility. There are going to be times when we lose money, sometimes a lot of money. There will be market downturns, corrections, crashes, etc. It is inevitable. As famed investor\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Peter_Lynch\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Peter Lynch<\/u><\/a>\u00a0says in his landmark book,\u00a0<a class=\"link-https\" title=\"https:\/\/www.google.com\/books\/edition\/One_Up_On_Wall_Street\/TYOdIrFJ2SkC?hl=en&amp;gbpv=1&amp;printsec=frontcover\" href=\"https:\/\/www.google.com\/books\/edition\/One_Up_On_Wall_Street\/TYOdIrFJ2SkC?hl=en&amp;gbpv=1&amp;printsec=frontcover\" target=\"_blank\" rel=\"external noopener nofollow\"><em>One Up on Wall Street<\/em><\/a>, \u201cA<\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">stock\u00a0market decline is as routine as a January blizzard in Colorado. If you\u2019re prepared, it can\u2019t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.\u201d The good news is that history also tells us that the\u00a0global\u00a0economy and the\u00a0stock\u00a0markets around the world have always come back from those snowstorms.<\/div>\r\n<p class=\"lt-biz-79465\">Please note that there are charlatans and grifters and con artists aplenty in the shadows of the\u00a0investment\u00a0industry. They will brazenly \u2012 and illegally, by the way \u2012 tell you that they can guarantee, for example, a 12%\u00a0risk-free average\u00a0annual rate of return. They are lying, pure and simple. There is no such thing as a 12%,\u00a0risk-free rate of return. It\u2019s a blue unicorn, a flying panda; it simply does not exist. Some crooks might even make claims of 300% or 3,000%. Check the\u00a0<a class=\"link-https\" title=\"https:\/\/wonderprofessor.com\/123\" href=\"https:\/\/wonderprofessor.com\/123\" target=\"_blank\" rel=\"external noopener nofollow\">class website<\/a>\u00a0for some examples. Or better yet, just type \u201c100% return in 3 days using options\u201d into any Internet search engine and see how many sharks want to separate you from your money.<\/p>\r\n\r\n<\/div>\r\n<div id=\"section_2\" class=\"mt-section\"><span id=\"Investing_versus_Speculating.2FTrading_.E2.80.92_Revisited\"><\/span>\r\n<h2 class=\"lt-biz-79465 editable\">Investing versus Speculating\/Trading \u2012 Revisited<\/h2>\r\n<p class=\"lt-biz-79465\">\u201c<em>But isn\u2019t someone doing it? Aren\u2019t there people who make tremendous rates of returns?<\/em>\u201d you may rightly ask. The answer is yes. There are individuals who make tremendous rates of return. But those people are not prudent,\u00a0long-term\u00a0investors like us. They are\u00a0<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/s\/speculation.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>speculators<\/u><\/a>, also known as traders. Being a\u00a0speculator\/trader\u00a0can be very profitable but it is also very stressful and perilous. Furthermore, you are up against the best in the world. Here is a quote from one of the famed speculators of the early 20<sup>th<\/sup>\u00a0century, Jesse Livermore.<\/p>\r\n\r\n<blockquote>\r\n<p class=\"lt-biz-79465\"><em>\u201cThe\u00a0<\/em>speculator<em>\u00a0is not an investor. His object is not to secure a steady return on his money at a good rate of\u00a0<\/em><\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">interest<em>, but to profit by either a rise or a fall in the price of whatever he may be speculating in.\u201d \u2013 Jesse Livermore<\/em><\/div><\/blockquote>\r\n<p class=\"lt-biz-79465\">So do you want to be an investor or a\u00a0speculator\/trader? As we mentioned at the beginning, we can help you learn how to become a patient, prudent, successful\u00a0long-term\u00a0investor. We cannot help you learn how to become a successful\u00a0short-term speculator. Sorry. We can\u2019t do it ourselves; how could we possibly teach anyone else to do it? If we have not yet convinced you to renounce any dreams you may have had of making riches quickly by day trading, surrounded by two computers and four monitors while simultaneously on the phone with two different companies, please take some time to listen to the story of\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/John_Gutfreund\" target=\"_blank\" rel=\"external noopener nofollow\"><u>John Gutfreund<\/u><\/a>\u00a0and\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/John_Meriwether\" target=\"_blank\" rel=\"external noopener nofollow\"><u>John Meriweather<\/u><\/a>\u00a0from the book\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Liar%27s_Poker\" target=\"_blank\" rel=\"external noopener nofollow\"><u><em>Liar\u2019s Poker<\/em><\/u><\/a>\u00a0by the accomplished<\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">investment\u00a0author\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Michael_Lewis\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Michael Lewis<\/u><\/a>. You never, ever want to play Liar\u2019s Poker with John Meriweather, let alone try to out trade him.<\/div>\r\n<p class=\"lt-biz-79465\">It\u2019s really very simple. When the task is immensely difficult and the competition is ferocious, as it is in speculating\/trading or in sports or the arts, for that matter, it is only natural that a select few will rise to the top. Can you throw or hit a fastball at 98 miles per hour? If you successfully can hit a fastball at 98 miles per hour three times out of ten tries, you can snag yourself a contract for tens of millions of dollars each year. Can you dunk a basketball? Can you sing the lead part in a five-act opera? Can you write or direct or act in a movie with a $100+ million dollar budget? Can you hit a tiny white ball 350 yards down the fairway in just three shots? The average person can\u2019t accomplish any of these. But that does not mean there aren\u2019t people who can. There are. Are you going to compete with them in their venue? I think not.<\/p>\r\n<p class=\"lt-biz-79465\">One of the best observations ever about investing versus speculating\/trading was made by\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/John_C._Bogle\" target=\"_blank\" rel=\"external noopener nofollow\"><u>John Bogle<\/u><\/a>, the founder of the\u00a0<a class=\"link-https\" href=\"https:\/\/investor.vanguard.com\/home\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Vanguard Group<\/u><\/a><\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">mutual fund\u00a0company. He was interviewed by\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Steve_Forbes\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Steve Forbes<\/u><\/a>, the Editor-in-Chief of\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Forbes\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Forbes<\/u><\/a>\u00a0magazine, back in 2009. The interview used to be available on the magazine\u2019s\u00a0<a class=\"link-https\" href=\"https:\/\/www.forbes.com\/\" target=\"_blank\" rel=\"external noopener nofollow\"><u>website<\/u><\/a>\u00a0but was taken down long ago. I contacted them and begged them to make it available again. I never got a response. So we put the passage here for you. Read carefully, Dear Students.<\/div>\r\n<blockquote>\r\n<p class=\"lt-biz-79465\"><em>\u201cWell, the first thing you have to think about is, and this is an issue that I\u2019ve almost never heard discussed, Steve, and that\u2019s the first question you have to ask yourself is: Am I an investor, or am I a\u00a0speculator? An investor is a person who owns business and holds it forever and enjoys the returns that U.S. businesses, and to some extent\u00a0<\/em><\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><em>global\u00a0businesses, have earned since the beginning of time. They have\u00a0capital, they earn a return on their\u00a0capital\u00a0and that\u00a0capital\u00a0grows over time. It\u2019s not complicated. That\u2019s the business of investing.<\/em><\/div>\r\n<div aria-expanded=\"false\"><\/div>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><em>Speculation\u00a0is betting on price. I think I can buy this for $10 and sell it for $12 or $14 or $20 or $100.\u00a0Speculation\u00a0has no place in the portfolio or the kit of the typical investor.\u00a0<\/em><\/div>\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><em>Speculation\u00a0leads you the wrong way. It allows you to put your emotion first, whereas\u00a0investment\u00a0gets emotions out of the picture. You own these businesses, they\u2019re still sound, if the market doesn\u2019t think they\u2019re worth as much as they were, well, pity, the market doesn\u2019t know everything.\u201d \u2012 John \u201cJack\u201d Bogle, Founder and former CEO of the Vanguard Group<\/em><\/div><\/blockquote>\r\n<p class=\"lt-biz-79465\">When the video was still available, we would show this segment in the face-to-face class and I would call out, \u201cWe do, Mr. Bogle! We do! We emphasize the distinction between investors and speculators\/traders in our Introduction to Investments class!\u201d The entire interview is over 30 minutes and highly informative and enterprising. Let\u2019s hope Forbes resurrects it.<\/p>\r\n<p class=\"lt-biz-79465\">Oh, by the way, Jesse Livermore, the famed\u00a0speculator\/trader, wound up heavily in debt and committed suicide. Please do not endeavor to become a\u00a0speculator\/trader. But if you do, we wish you the best of luck. You\u2019ll need it.<\/p>\r\n\r\n<\/div>\r\n<div id=\"section_3\" class=\"mt-section\"><span id=\"Observations_about_the_End_of_the_World\"><\/span>\r\n<h2 class=\"lt-biz-79465 editable\">Observations about the End of the World<\/h2>\r\n<p class=\"lt-biz-79465\">Some readers will ask, \u201cWell, what if\u00a0stock\u00a0prices all go to zero? What if the economy and the\u00a0stock market don\u2019t come back?\u201d This is a very probing question. It speaks to our justifiable fears about investing, especially in stocks. Let\u2019s rephrase the question: What if the world ends? The truth is someday the world is going to end. There are numerous scenarios. For example, we know that in about 1 or 2 billion years, the sun will expand and swallow Mercury and Venus and maybe even the Earth. However, it won\u2019t need to swallow the Earth for our world to end. By the time it gets to Venus, temperatures on the Earth will be hot enough to melt tin and lead and copper. Thankfully, we have a long time to prepare for this scenario. But what about all the other disasters looming on our horizon?\u00a0Global\u00a0warming, climate change,\u00a0income\u00a0inequality, nuclear war, rising sea levels, pandemics, tsunamis, earthquakes, fires, floods, disco returning!<\/p>\r\n<p class=\"lt-biz-79465\">As we said at the beginning, there will always be proclamations of doom and gloom, especially from charlatans ready to sell you their sure-fire method for surviving the end times. Don\u2019t listen to them! If the world does end, if our technologically based civilization cracks and falls and dissolves into a pool of tears, if there is no food at the grocery store, no gas at the gas station, no clothes at the mall, the cell phones aren\u2019t working, the utility companies are not pumping out electricity or natural gas, the trash isn\u2019t being picked up, the sewers are clogged, the hospitals, schools, fire departments, police stations, banks are all boarded up, etc., your\u00a0stock\u00a0portfolio will be the last thought on your mind. You will be digging for beetle grubs and boiling bark for dinner. Let\u2019s meet at the beach. You bring the marshmallows. I\u2019ll bring the vodka. We can get drunk and watch the world burn.<\/p>\r\n<p class=\"lt-biz-79465\">Take heart, Dear Students! This scenario is not going to happen! Failure is not an option! As I have already told you, Your Humble Author is firmly convinced that the next 20, 30, 50 years are going to be the most prosperous years in the history of our civilization. There is no doubt that we have tremendous hurdles to overcome, some might say they are insurmountable. But never underestimate the innovative power of our species. Just look at what we did with Covid in 2020. A vaccine usually takes at least 4 years and often up to 10 years to develop. Multiple groups around the world created safe and effective vaccines in a matter of months! We will overcome climate change. We will phase out fossil fuels. We will have driverless cars and some will be able to fly. We will cure cancer. We will colonize Mars. We will have universal language translators. We will have\u00a0domestic\u00a0robots. We will see the day when close to 100% of the citizens of our world are connected to the Internet. We will ensure that never again does disco become the dominant cultural icon of our nation! Economically, I am very confident of this and more. (Politically, I am very scared. Democracy is being attacked in many countries around the world, including the United States. But that discussion is for another class in another department. Thank goodness this isn\u2019t Kindergarten where all the disciplines are taught in the same classroom. Go take up our political woes with your Political Science professor.)<\/p>\r\n\r\n<\/div>\r\n<div id=\"section_4\" class=\"mt-section\"><span id=\"So_What_Is_a_Realistic_Rate_of_Return_for_Me.3F\"><\/span>\r\n<h2 class=\"lt-biz-79465 editable\">So What Is a Realistic\u00a0Rate of Return\u00a0for Me?<\/h2>\r\n<p class=\"lt-biz-79465\">After you have taken this course, you will have a strong foundation of the most popular types of securities investments: stocks, bonds, \u201ccash,\u201d and mutual funds. You will also know what levels of returns and what levels of risks you should reasonably expect to receive. And if you are a patient,\u00a0long-term\u00a0investor, I believe it is realistic to expect 8% to 10%. I am certainly working on it myself. So far, so good. Of course, as we will reiterate time and time again, there are no guarantees.<\/p>\r\n<p class=\"lt-biz-79465\">You are now most likely thinking, \u201c<em>But is 8% or 9% or 10% good enough for me?<\/em>\u201d It turns out the answer to this question is a resounding, \u201cYes!\u201d There are some caveats we need to add, though. If you start early, if you invest patiently and consistently, if you do not get cocky or greedy, if you do not chase after every \u201cNext Big Thing\u201d that comes along, and most importantly,\u00a0<em><strong>you do not panic when the market swoons,\u00a0<\/strong><\/em>as it inevitably will do from time to time, then \u2012 unless the world ends \u2012 we believe it is entirely reasonable and realistic to expect 8% or 9% or 10% over the long term. As mentioned, some investors have done better. The trick is to take advantage of the\u00a0<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/t\/timevalueofmoney.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>time value of money<\/u><\/a>, also known as the\u00a0<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/c\/cagr.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>compound annual return<\/u><\/a>\u00a0or the compound annual\u00a0growth rate. The time value of money is the amount to which a sum you invest now will increase based on a specified\u00a0rate of return\u00a0and time period. Calculating amounts into the future is called\u00a0<u><\/u>compounding<u><\/u>. The result is the\u00a0<u><\/u>future value<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/f\/futurevalue.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>\u00a0of money<\/u><\/a>.\u00a0Future value\u00a0can be computed for a single amount, also known as a lump sum, a<\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">principal, or a single payment.\u00a0Future value can also be determined for a series of deposits, also known as a stream of investments or an\u00a0annuity. (In our class, we usually don\u2019t use the term\u00a0annuity\u00a0because an\u00a0annuity\u00a0is also an insurance product. We discuss\u00a0annuity\u00a0insurance products at the end of the class. We do not have kind words for them.)<\/div>\r\n<p class=\"lt-biz-79465\">There is a\u00a0<u><\/u>future value<a class=\"link-https\" href=\"https:\/\/docs.google.com\/document\/d\/1_aLteHaZmC94VdDHl9vtOVIC0l0geVDmUV6auOlEinQ\/\" target=\"_blank\" rel=\"external noopener nofollow\"><u>\u00a0handout<\/u><\/a>\u00a0available on the\u00a0<a class=\"link-https\" title=\"https:\/\/wonderprofessor.com\/123\/\" href=\"https:\/\/wonderprofessor.com\/123\/\" target=\"_blank\" rel=\"external noopener nofollow\">class website<\/a>. We leave the calculations to you as an optional exercise.\u00a0Quite possibly you have already taken our Financial Planning and Money Management, now called\u00a0<a class=\"link-https\" title=\"https:\/\/wonderprofessor.com\/121\/\" href=\"https:\/\/wonderprofessor.com\/121\/\" target=\"_blank\" rel=\"external noopener nofollow\">Principles of Money Management<\/a>, class at Southwestern. We spend a good deal of time learning\u00a0future value\u00a0calculations in Principles of Money Management. At the very least, please review the\u00a0<a class=\"link-https\" href=\"https:\/\/docs.google.com\/document\/d\/16zBZ5rvydSxfuEot-UWv_Gr0AspslE2LgxQIiCnJtr0\/\" target=\"_blank\" rel=\"external noopener nofollow\"><u>answer key<\/u><\/a>\u00a0and listen to the\u00a0<a class=\"link-https\" href=\"https:\/\/wonderprofessor.com\/123s21\/Chap01\/Chap01_FutureValueCommentary.mp3\" target=\"_blank\" rel=\"external noopener nofollow\"><u>commentary<\/u><\/a>\u00a0to see the kinds of wealth that one can reasonably build over the working careers. We will also see some great examples in our next chapter on mutual funds. The news is good!<\/p>\r\n<p class=\"lt-biz-79465\">The\u00a0future value\u00a0calculations allow us to move from the present into the future. Later on, when we learn how to assign valuations to stocks and bonds, we will use the inverse of<\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">future value,\u00a0<u><\/u>present value<u><\/u>, to move from the future back to the present. (\u201c<em>Huh? What?<\/em>\u201d Relax. Study what is in this chapter. We have a long road ahead of us.)<\/div>\r\n<p class=\"lt-biz-79465\">So are you ready to start your journey to become a prudent,\u00a0long-term\u00a0investor? Are you excited? I know I am! Well, before we get to the good stuff, we are going to take a small detour. We will now revisit\u00a0short-term\u00a0investments, vehicles that we use if we need the money in three, six, or nine months or even a year or two, depending upon the importance of the uses for the\u00a0short-term\u00a0funds.\u00a0Short-term\u00a0investments aren\u2019t very exciting. They aren\u2019t supposed to be. We don\u2019t want excitement with money that we need in the short term. We want certainty.<\/p>\r\n\r\n<\/div>\r\n<div id=\"section_5\" class=\"mt-section\"><span id=\".E2.80.9COh.2C_yeah.3F!_This_guy_says_I_can_earn_25.25_per_month!_Whaddya.E2.80.99_say_about_that.2C_huh.3F.E2.80.9D\"><\/span>\r\n<h1 class=\"lt-biz-79465 editable\">\u201cOh, yeah?! This guy says I can earn 25% per month! Whaddya\u2019 say about that, huh?\u201d<\/h1>\r\n<p class=\"lt-biz-79465\">Before we move on to\u00a0short-term\u00a0investments, we want to warn you again that there are plenty of con artists out there ready to take your money. Dear Students, if you are involved in the\u00a0investment\u00a0world for any period of time, eventually you are going to come across an advertisement, flyer, electronic mail or United States mail solicitation that promises eye-popping returns of 25%, 100%, 3,000% per year or even 300% or more per day.\u00a0Investment\u00a0scams have been with us forever. They will always be with us. Sadly, many uninformed individuals fall for their snake oil. Here is an example of one such outrageous claim:<\/p>\r\n<p class=\"lt-biz-79465\"><img class=\"default\" src=\"https:\/\/lh3.googleusercontent.com\/8rQ1BB5nJQiUujkQNUWWiP-pXpjeq5npzWv8ENqHefsjBgBRbWMEfXksqTSFO1J7b6qcETxYLMuDt5sbKobXoVzPgAZ-SCVxkJpHnX-qtNeOMixrhHUeet9-5KwcueceBal-B0I7=s0\" alt=\"Scam artists plying his snake oil.\" \/><\/p>\r\n<p class=\"lt-biz-79465\">This advertisement was found on the Yahoo! Finance web site which is generally considered a reliable and reputable media outlook. Prepare to see far more outlandish and preposterous claims on less reputable locations. This guy is claiming that he was able to\u00a0<a class=\"link-https\" href=\"https:\/\/wonderprofessor.com\/123\/Chap01\/Chap01_Turn_33000_Into_7000000_In_2_Years.pdf\" target=\"_blank\" rel=\"external noopener nofollow\"><u>generate returns of 25% per month<\/u><\/a>. That is over 1,300% per year. This is total rubbish!<\/p>\r\n<p class=\"lt-biz-79465\">Oh, by the way, these advertisements are against the law. \u201cWhat?! Huh?! Don\u2019t we have freedom of speech in the United States?\u201d you ask. Well, yes, you are correct. We are free to express our viewpoints, opinion, and our understanding of the facts in the marketplace of ideas. But when it comes to<\/p>\r\n\r\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">investment<\/div>\r\n<p class=\"lt-biz-79465\">\u00a0advice and products, that freedom of speech is severely limited. So how do people get away with this? The Securities and Exchange Commission has a skeletal crew of regulators that can not begin to tackle this problem. They only go after the worst scoundrels. The same kind of illegal behaviors also go on in the\u00a0<a class=\"link-https\" href=\"https:\/\/nutritionfacts.org\/video\/are-weight-loss-supplements-effective\/?utm_source=NutritionFacts.org&amp;utm_campaign=40a90d1e8d-RSS_VIDEO_DAILY&amp;utm_medium=email&amp;utm_term=0_40f9e497d1-40a90d1e8d-27157657&amp;mc_cid=40a90d1e8d&amp;mc_eid=6b95979a51\" target=\"_blank\" rel=\"external noopener nofollow\"><u>world of weight loss supplements<\/u><\/a>. Some even sneak controlled, prescription-only drugs such as Prozac and Viagra into their products and some even put dangerous, banned chemical substances. Be careful out there, Dear Students!<\/p>\r\n\r\n<\/div>\r\n<footer class=\"mt-content-footer\">\r\n\r\n<hr class=\"autoattribution-divider\" \/>\r\n\r\n<div class=\"autoattribution\">\r\n\r\nThis page titled\u00a0<a class=\"internal mt-self-link\" href=\"https:\/\/biz.libretexts.org\/Bookshelves\/Finance\/Introduction_to_Investments_(Paiano)\/01%3A_Chapter_1\/01%3A_Introduction_Overview_and_Risk_versus_Return\/1.04%3A_Risk_versus_Return__The_Eternal_Struggle_of_Investing\" target=\"_blank\" rel=\"internal noopener\">1.4:\u00a0<\/a>Risk<a class=\"internal mt-self-link\" href=\"https:\/\/biz.libretexts.org\/Bookshelves\/Finance\/Introduction_to_Investments_(Paiano)\/01%3A_Chapter_1\/01%3A_Introduction_Overview_and_Risk_versus_Return\/1.04%3A_Risk_versus_Return__The_Eternal_Struggle_of_Investing\" target=\"_blank\" rel=\"internal noopener\">\u00a0versus Return \u2012 The Eternal Struggle of Investing<\/a>\u00a0is shared under a\u00a0<a href=\"https:\/\/creativecommons.org\/licenses\/by-nc-sa\/4.0\" target=\"_blank\" rel=\"nofollow noopener\">CC BY-NC-SA 4.0<\/a>\u00a0license and was authored, remixed, and\/or curated by\u00a0<a href=\"https:\/\/wonderprofessor.com\/\" target=\"_blank\" rel=\"nofollow noopener\">Frank Paiano<\/a>.\r\n\r\n<\/div>\r\n<div id=\"librelens-attribution-list\"><\/div>\r\n<\/footer><\/section>","rendered":"<section class=\"mt-content-container\">\n<p class=\"lt-biz-79465\"><iframe loading=\"lazy\" id=\"iFrameResizer0\" title=\"Chapter 01 - Slides 35-54 - Risk versus Return\" src=\"https:\/\/wonderprofessor.com\/123\/Chap01\/Chap01_Slides_35_to_53\/Chap01_Slides_35_to_53.html\" width=\"640\" height=\"480\" allowfullscreen=\"allowfullscreen\" data-mce-fragment=\"1\"><\/iframe><\/p>\n<p class=\"lt-biz-79465\">Here it is, Dear Readers! This is the entire course in one section! Do you want to eat well or do you want to sleep well? By now, you should be seeing that there is a pattern in the world of investments. The more return you want from your investments, the more\u00a0risk\u00a0you will have to accept. In the previous section, we saw that stocks have given us the best returns over time but have also subjected us to the most\u00a0risk. Bonds are less risky but give us less return.\u00a0Short-term\u00a0investments are\u00a0risk\u00a0free or pretty darned close but they pay very little. Mutual funds will more or less reflect the underlying assets that they invest in. In the corresponding presentation on\u00a0risk\u00a0versus return, you will see how these various\u00a0investment\u00a0asset classes have done over very long periods of time. We see that stocks are the stars! Bonds are a distant second. And\u00a0short-term\u00a0investments have barely kept up with inflation and currently are losing to inflation. Take a quick look at this graph that compares stocks (businesses), bonds (loans), Treasury bills (short-term\u00a0guaranteed investments), and inflation as measured by the Consumer Price Index.<\/p>\n<p class=\"lt-biz-79465\"><img decoding=\"async\" class=\"internal\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/41151\/1928_2022_Stocks_Bonds_Cash_CPI_Logarithmic_With_Warning.png?revision=1&amp;size=bestfit&amp;width=735&amp;height=471\" alt=\"The Growth of $1 in Stocks, Bonds, &quot;Cash,&quot; and Inflation. Returns from 1928 to 2022. Warning: Logarithmic Scale!\" width=\"735px\" height=\"471px\" \/><\/p>\n<p class=\"lt-biz-79465\">Source:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\"><u>NYU Stern School of Business<\/u><\/a>,\u00a0<a class=\"link-https\" href=\"https:\/\/www.minneapolisfed.org\/about-us\/monetary-policy\/inflation-calculator\/consumer-price-index-1913-\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Federal Reserve Bank of Minneapolis<\/u><\/a><\/p>\n<p class=\"lt-biz-79465\">We see that the rewards from investing in businesses via stocks have completely overwhelmed the two other choices and have handily beaten inflation. However, what is different about this graph than most graphs we are used to viewing? What is this graph hiding? In this graph and many graphs in the world of investing, we use a logarithmic scale. In the opinion of Your Humble Author, all graphs using a logarithmic scale should have warning labels attached to them since most individuals don\u2019t completely understand how they work. Each unit on the left is 10 times bigger than the previous unit. Logarithmic graphs are used when the numbers grow exponentially. The graph is hiding the enormous difference between stocks on the one hand and bonds, Treasury bills, and inflation on the other. It is also minimizing the large downturns that stocks experience from time to time. Here is an arithmetic version of the same graph:<\/p>\n<p class=\"lt-biz-79465\"><img decoding=\"async\" class=\"internal\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/41152\/1928_2022_Stocks_Bonds_Cash_CPI_Arithmetic.png?revision=1&amp;size=bestfit&amp;width=719&amp;height=517\" alt=\"The Growth of $1 in Stocks, Bonds, &quot;Cash,&quot; and Inflation. Returns from 1928 to 2022. Arithmetic Scale.\" width=\"719px\" height=\"517px\" \/><\/p>\n<p class=\"lt-biz-79465\">Do you see why we initially used a logarithmic scale? Because of the enormous differences in results, the bonds,\u00a0Treasury bill, and inflation don\u2019t even begin to show any rise in value in the arithmetic graph. Around 1988, the arithmetic graph also begins to show us the exponential curve that stocks exhibit. It also highlights that what we thought were little rises and falls in the price of stocks are actually very dramatic. Stocks are volatile!<\/p>\n<p>What happens if we go back to the dawn of the Industrial Revolution?<\/p>\n<p class=\"lt-biz-79465\"><img decoding=\"async\" class=\"internal\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/41153\/1801-2022-Returns_Massaged.png?revision=1&amp;size=bestfit&amp;width=698&amp;height=476\" alt=\"The Growth of $1 Since the Dawn of the Industrial Revolution. Returns of stocks, bonds, &quot;cash&quot; investments, gold, and inflation, 1801 to 2022.\" width=\"698px\" height=\"476px\" \/><\/p>\n<p class=\"lt-biz-79465\">The numbers become staggering and we are left with a few takeaways. Bonds and &#8220;cash&#8221; investments have done admirably; they have beaten inflation. Gold? Not so much. However, stocks are the hands-down best choice, right? Well, yes, but again, let&#8217;s not be too hasty. We need to look at the other side of investing,\u00a0risk, as well as the return. We will examine in detail the risks involved with\u00a0stock\u00a0investing soon.It is no accident that stocks and bonds have produced better returns than\u00a0short-term\u00a0investments. If that were not the case, why would investors assume the higher risks of stocks and bonds? The answer is they would not. If guaranteed (or pretty darned close to being guaranteed)\u00a0short-term\u00a0investments returned the same as stocks or bonds, investors would prefer those guaranteed\u00a0short-term\u00a0investments. They would choose an\u00a0investment\u00a0for which there is no chance of losing money and they would be happy to accept the\u00a0<u><\/u>risk-free rate of return<u><\/u>\u00a0on their money. In theory, there is no\u00a0investment\u00a0with absolute zero\u00a0risk. However,\u00a0short-term\u00a0United States Treasury bills come as close to absolute zero\u00a0risk\u00a0as you can get in this world. Therefore, when investors want to know what the current\u00a0risk-free rate of return\u00a0is, they often look at the\u00a0interest\u00a0rate that three-month United States Treasury Bills are currently paying. (We will cover Treasury Bills in more detail in our next section dedicated to\u00a0short-term\u00a0investments.)To make prudent<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">investment\u00a0decisions, we investors need to know what the\u00a0<u><\/u>risk<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/r\/riskpremium.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>\u00a0premium<\/u><\/a>\u00a0is for our potential investors. The\u00a0risk\u00a0premium is the reward for bearing\u00a0risk. It is the extra return on a risky asset over the return that we receive from a\u00a0risk-free rate of return. As we would expect, the\u00a0risk\u00a0premium for stocks is the highest at over 8%. The\u00a0risk\u00a0premium for large company bonds is a bit less than 4% and less than 2% for government bonds. Here are the\u00a0risk\u00a0premiums for large company stocks, large company bonds, government bonds, and Treasury bills (guaranteed\u00a0short-term&#8221; cash&#8221; investments).<\/div>\n<table class=\"mt-responsive-table\" summary=\"Investment Risk Premiums from 1928 to 2022\">\n<caption>Investment Risk Premiums from 1928 to 2022<\/caption>\n<colgroup>\n<col width=\"160\" \/>\n<col width=\"174\" \/>\n<col width=\"175\" \/><\/colgroup>\n<thead>\n<tr>\n<th class=\"mt-align-center\" scope=\"col\">Investment<\/th>\n<th class=\"mt-align-center\" scope=\"col\">Average Return<\/th>\n<th class=\"mt-align-center\" scope=\"col\">Risk Premium<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Large Company Stocks<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">11.51%<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">8.17%<\/td>\n<\/tr>\n<tr>\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Large Company Bonds<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">6.99%<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">3.62%<\/td>\n<\/tr>\n<tr>\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Government Bonds<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">4.87%<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">1.53%<\/td>\n<\/tr>\n<tr>\n<td class=\"lt-biz-79465\" data-th=\"Investment\">Treasury Bills (&#8220;Cash&#8221;)<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Average Return\">3.34%<\/td>\n<td class=\"mt-align-center lt-biz-79465\" data-th=\"Risk Premium\">0.00%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p class=\"lt-biz-79465\">Source:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\"><u>NYU Stern School of Business<\/u><\/a>,\u00a0<a class=\"link-https\" href=\"https:\/\/www.minneapolisfed.org\/about-us\/monetary-policy\/inflation-calculator\/consumer-price-index-1913-\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Federal Reserve Bank of Minneapolis<\/u><\/a><\/p>\n<p class=\"lt-biz-79465\">These\u00a0risk\u00a0premiums may not seem like much but over time, the effects of the higher returns are enormous as we saw in the graphics above and in the presentation.\u00a0Investment\u00a0returns are very easy to measure. How much did you start with? How much did you end with? How long did it take you to earn this amount? From this information, we can calculate your return. But what about the risks involved. How do we measure\u00a0risk?<\/p>\n<div id=\"section_1\" class=\"mt-section\"><span id=\"Variance_and_Standard_Deviation_.E2.80.92_Two_Imperfect_Measures_of_Risk\"><\/span><\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><\/div>\n<h2 class=\"lt-biz-79465 editable\">Variance and Standard Deviation\u2012 Two Imperfect Measures of Risk<\/h2>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">Investment risk, on the other hand, is much more difficult to measure. The reality is that\u00a0risk\u00a0is impossible to measure and predict. There is no measurement that accurately reflects the amount of\u00a0risk\u00a0that investors must accept when choosing an\u00a0investment. That does not stop us from trying, though. Each year, the\u00a0investment\u00a0community measures the average annual return and the amount of\u00a0variance\u00a0from the average return. Using statistics, the resulting measures of\u00a0risk\u00a0are called\u00a0<u><\/u>variance<u><\/u>\u00a0and\u00a0<u><\/u>standard deviation<u><\/u>. By far, the most popular measure of\u00a0risk\u00a0is\u00a0standard deviation.\u00a0Standard deviation is the measure we will use for our class. I already know what you are thinking. \u201c<em>Aye, this is math! I need to drop this class!<\/em>\u201d Relax. Please don\u2019t drop the class. We don\u2019t do any\u00a0variance\u00a0or\u00a0standard deviation\u00a0calculations. We leave those calculations for your statistics class. We just do a quick library or Internet search and the\u00a0investment\u00a0community readily and happily gives us the results. Please. Don\u2019t drop the class. Keep reading.<\/div>\n<div aria-expanded=\"false\"><\/div>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">It is important to understand what the\u00a0variance\u00a0and its more popular and important companion,\u00a0standard deviation, can tell us about a potential\u00a0investment. In general,\u00a0<strong>the higher the\u00a0<\/strong><\/div>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">variance<strong>\u00a0and\u00a0<\/strong>standard deviation<strong>, the riskier the\u00a0<\/strong>investment<strong>.<\/strong>\u00a0The higher the\u00a0variance and\u00a0standard deviation, the more the\u00a0investment\u00a0return will deviate from the average annual return of that\u00a0investment. In other words, we said that stocks can give us an average annual return of 8%, 9% or even 10% over the long term but we also know that in any one year, the probability is very high that we won\u2019t get 8% or 9% or 10%. We might get +17% in one year, -9% the next year, +22% after that, and then -4%. With stocks, the variances and deviations from the annual returns are extreme. A high\u00a0standard deviation\u00a0means the\u00a0volatility\u00a0is high. The\u00a0investment\u00a0is risky.<\/div>\n<div aria-expanded=\"false\"><\/div>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">Please take a close look at the following frequency distribution graph:<\/div>\n<p class=\"lt-biz-79465\"><img decoding=\"async\" class=\"internal default\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/45786\/NormalDistribution_2022_Book.jpg?revision=1&amp;size=bestfit&amp;width=769&amp;height=433\" alt=\"The normal distribution, also known as the normal curve or the bell curve. Stock market returns tend to follow the normal distribution.\" width=\"769px\" height=\"433px\" \/><\/p>\n<p class=\"lt-biz-79465\">Source:\u00a0<a class=\"external\" title=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\">NYU Stern School of Business<\/a><\/p>\n<p>How do we interpret this graph? This graph shows us the annual returns from the\u00a0stock\u00a0market for every year from 1926 until 2022. Each year is placed in the column that corresponds to the return for that year. For example, in 2020, the return from the\u00a0stock\u00a0market was between 10% and 20%. In 2015, the return was between 0% and 10%. In 2018, the return was between -10% and 0%.<\/p>\n<p class=\"lt-biz-79465\">From the graph, we see that stocks are similar to Henry Longfellow\u2019s little girl with the little curl right in the middle of her forehead. When she was good, she was very, very good, but when she was bad, she was horrid. \u201c<em>Minus 20% in 2001 and 2022, minus 30% in 2002, minus 40% in 2008!? No way! Not for me! I ain\u2019t gettin\u2019 involved in investing in stocks,<\/em>\u201d is how some people react. Relax. Calm down. We are going to learn how to use this\u00a0volatility\u00a0to our advantage. We can make\u00a0volatility\u00a0our friend, not our enemy.<\/p>\n<p>Also, does the\u00a0distribution graph above resemble anything that you are familiar with? Why yes, you may remember it as the normal curve, also known as the normal distribution or the bell curve. Here it is in all its mathematical glory:<\/p>\n<p class=\"lt-biz-79465\"><img decoding=\"async\" class=\"internal default\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/45787\/NormalDistribution_Ferran_Mathematical.png?revision=1&amp;size=bestfit&amp;width=860&amp;height=490\" alt=\"The normal distribution, also known as the normal curve or the bell curve. Stock market returns tend to follow the normal distribution.\" width=\"860px\" height=\"490px\" \/><\/p>\n<p>Source:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\">NYU Stern School of Business<\/a>\u00a0; Graphics courtesy of Ferran Capo:\u00a0<a class=\"external\" href=\"http:\/\/www.ferrancapo.com\/\" target=\"_blank\" rel=\"external noopener nofollow\">StudioCapo<\/a><\/p>\n<p>If you are allergic to all things mathematical, please feel free to ignore the above graphic and just read on. What this graph is trying to show us is that the returns from the<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">stock\u00a0market tend to clump around the average return for the past century. What the graph is also telling us is that the probability that we will actually get that market average is quite low. We can\u2019t know what the return will be next year but history tells us there is about a two-thirds chance that the return will be between \u20118.0% and 31.0%. There is a 95% probability that the return will be between \u201127.5% and 50.5%. And there is a better than 99% chance that the return will be between \u201147.0% and 70.0%.<\/div>\n<p>Here is another view of\u00a0risk\u00a0versus return:<\/p>\n<p><img decoding=\"async\" class=\"internal default\" src=\"https:\/\/biz.libretexts.org\/@api\/deki\/files\/45788\/Investments_Returns_and_Standard_Deviations.png?revision=1&amp;size=bestfit&amp;width=844&amp;height=225\" alt=\"The greater the average annual return, the greater the standard deviation and the riskier the investment.\" width=\"844px\" height=\"225px\" \/><\/p>\n<p>Source:\u00a0<a class=\"external\" href=\"http:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/histretSP.html\" target=\"_blank\" rel=\"external noopener nofollow\">NYU Stern School of Business<\/a>,\u00a0<a class=\"link-https\" href=\"https:\/\/www.minneapolisfed.org\/about-us\/monetary-policy\/inflation-calculator\/consumer-price-index-1913-\" target=\"_blank\" rel=\"external noopener nofollow\">Federal Reserve Bank of Minneapolis<\/a><\/p>\n<p>If we start with Treasury Bills, the least risky\u00a0investment, and work our way up to stocks, we see the average annual return rise but we also see the\u00a0standard deviation\u00a0rise. It is a bit interesting that the corporate bonds gave us more return while actually having a bit less\u00a0volatility.<\/p>\n<p class=\"lt-biz-79465\"><i>\u201cSo, does you\u2019se got\u2019s it yet? You\u2019se wants\u00a0<b>high returns<\/b>? You\u2019se gonna\u2019 gets\u00a0<b>high\u00a0<\/b><\/i><strong>risk<\/strong><i><b><\/b>! You\u2019se gonna\u2019 lose some money, maybe a lot o\u2019 money! And if\u2019n anybodies tells you\u2019se differently, de\u2019re lying!\u201d<\/i><\/p>\n<p class=\"lt-biz-79465\">The lessons from history are that if we want high average annual returns, we are going to have to accept high\u00a0risk\u00a0and high\u00a0volatility. There are going to be times when we lose money, sometimes a lot of money. There will be market downturns, corrections, crashes, etc. It is inevitable. As famed investor\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Peter_Lynch\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Peter Lynch<\/u><\/a>\u00a0says in his landmark book,\u00a0<a class=\"link-https\" title=\"https:\/\/www.google.com\/books\/edition\/One_Up_On_Wall_Street\/TYOdIrFJ2SkC?hl=en&amp;gbpv=1&amp;printsec=frontcover\" href=\"https:\/\/www.google.com\/books\/edition\/One_Up_On_Wall_Street\/TYOdIrFJ2SkC?hl=en&amp;gbpv=1&amp;printsec=frontcover\" target=\"_blank\" rel=\"external noopener nofollow\"><em>One Up on Wall Street<\/em><\/a>, \u201cA<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">stock\u00a0market decline is as routine as a January blizzard in Colorado. If you\u2019re prepared, it can\u2019t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.\u201d The good news is that history also tells us that the\u00a0global\u00a0economy and the\u00a0stock\u00a0markets around the world have always come back from those snowstorms.<\/div>\n<p class=\"lt-biz-79465\">Please note that there are charlatans and grifters and con artists aplenty in the shadows of the\u00a0investment\u00a0industry. They will brazenly \u2012 and illegally, by the way \u2012 tell you that they can guarantee, for example, a 12%\u00a0risk-free average\u00a0annual rate of return. They are lying, pure and simple. There is no such thing as a 12%,\u00a0risk-free rate of return. It\u2019s a blue unicorn, a flying panda; it simply does not exist. Some crooks might even make claims of 300% or 3,000%. Check the\u00a0<a class=\"link-https\" title=\"https:\/\/wonderprofessor.com\/123\" href=\"https:\/\/wonderprofessor.com\/123\" target=\"_blank\" rel=\"external noopener nofollow\">class website<\/a>\u00a0for some examples. Or better yet, just type \u201c100% return in 3 days using options\u201d into any Internet search engine and see how many sharks want to separate you from your money.<\/p>\n<\/div>\n<div id=\"section_2\" class=\"mt-section\"><span id=\"Investing_versus_Speculating.2FTrading_.E2.80.92_Revisited\"><\/span><\/p>\n<h2 class=\"lt-biz-79465 editable\">Investing versus Speculating\/Trading \u2012 Revisited<\/h2>\n<p class=\"lt-biz-79465\">\u201c<em>But isn\u2019t someone doing it? Aren\u2019t there people who make tremendous rates of returns?<\/em>\u201d you may rightly ask. The answer is yes. There are individuals who make tremendous rates of return. But those people are not prudent,\u00a0long-term\u00a0investors like us. They are\u00a0<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/s\/speculation.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>speculators<\/u><\/a>, also known as traders. Being a\u00a0speculator\/trader\u00a0can be very profitable but it is also very stressful and perilous. Furthermore, you are up against the best in the world. Here is a quote from one of the famed speculators of the early 20<sup>th<\/sup>\u00a0century, Jesse Livermore.<\/p>\n<blockquote>\n<p class=\"lt-biz-79465\"><em>\u201cThe\u00a0<\/em>speculator<em>\u00a0is not an investor. His object is not to secure a steady return on his money at a good rate of\u00a0<\/em><\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">interest<em>, but to profit by either a rise or a fall in the price of whatever he may be speculating in.\u201d \u2013 Jesse Livermore<\/em><\/div>\n<\/blockquote>\n<p class=\"lt-biz-79465\">So do you want to be an investor or a\u00a0speculator\/trader? As we mentioned at the beginning, we can help you learn how to become a patient, prudent, successful\u00a0long-term\u00a0investor. We cannot help you learn how to become a successful\u00a0short-term speculator. Sorry. We can\u2019t do it ourselves; how could we possibly teach anyone else to do it? If we have not yet convinced you to renounce any dreams you may have had of making riches quickly by day trading, surrounded by two computers and four monitors while simultaneously on the phone with two different companies, please take some time to listen to the story of\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/John_Gutfreund\" target=\"_blank\" rel=\"external noopener nofollow\"><u>John Gutfreund<\/u><\/a>\u00a0and\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/John_Meriwether\" target=\"_blank\" rel=\"external noopener nofollow\"><u>John Meriweather<\/u><\/a>\u00a0from the book\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Liar%27s_Poker\" target=\"_blank\" rel=\"external noopener nofollow\"><u><em>Liar\u2019s Poker<\/em><\/u><\/a>\u00a0by the accomplished<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">investment\u00a0author\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Michael_Lewis\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Michael Lewis<\/u><\/a>. You never, ever want to play Liar\u2019s Poker with John Meriweather, let alone try to out trade him.<\/div>\n<p class=\"lt-biz-79465\">It\u2019s really very simple. When the task is immensely difficult and the competition is ferocious, as it is in speculating\/trading or in sports or the arts, for that matter, it is only natural that a select few will rise to the top. Can you throw or hit a fastball at 98 miles per hour? If you successfully can hit a fastball at 98 miles per hour three times out of ten tries, you can snag yourself a contract for tens of millions of dollars each year. Can you dunk a basketball? Can you sing the lead part in a five-act opera? Can you write or direct or act in a movie with a $100+ million dollar budget? Can you hit a tiny white ball 350 yards down the fairway in just three shots? The average person can\u2019t accomplish any of these. But that does not mean there aren\u2019t people who can. There are. Are you going to compete with them in their venue? I think not.<\/p>\n<p class=\"lt-biz-79465\">One of the best observations ever about investing versus speculating\/trading was made by\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/John_C._Bogle\" target=\"_blank\" rel=\"external noopener nofollow\"><u>John Bogle<\/u><\/a>, the founder of the\u00a0<a class=\"link-https\" href=\"https:\/\/investor.vanguard.com\/home\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Vanguard Group<\/u><\/a><\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">mutual fund\u00a0company. He was interviewed by\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Steve_Forbes\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Steve Forbes<\/u><\/a>, the Editor-in-Chief of\u00a0<a class=\"link-https\" href=\"https:\/\/en.wikipedia.org\/wiki\/Forbes\" target=\"_blank\" rel=\"external noopener nofollow\"><u>Forbes<\/u><\/a>\u00a0magazine, back in 2009. The interview used to be available on the magazine\u2019s\u00a0<a class=\"link-https\" href=\"https:\/\/www.forbes.com\/\" target=\"_blank\" rel=\"external noopener nofollow\"><u>website<\/u><\/a>\u00a0but was taken down long ago. I contacted them and begged them to make it available again. I never got a response. So we put the passage here for you. Read carefully, Dear Students.<\/div>\n<blockquote>\n<p class=\"lt-biz-79465\"><em>\u201cWell, the first thing you have to think about is, and this is an issue that I\u2019ve almost never heard discussed, Steve, and that\u2019s the first question you have to ask yourself is: Am I an investor, or am I a\u00a0speculator? An investor is a person who owns business and holds it forever and enjoys the returns that U.S. businesses, and to some extent\u00a0<\/em><\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><em>global\u00a0businesses, have earned since the beginning of time. They have\u00a0capital, they earn a return on their\u00a0capital\u00a0and that\u00a0capital\u00a0grows over time. It\u2019s not complicated. That\u2019s the business of investing.<\/em><\/div>\n<div aria-expanded=\"false\"><\/div>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><em>Speculation\u00a0is betting on price. I think I can buy this for $10 and sell it for $12 or $14 or $20 or $100.\u00a0Speculation\u00a0has no place in the portfolio or the kit of the typical investor.\u00a0<\/em><\/div>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\"><em>Speculation\u00a0leads you the wrong way. It allows you to put your emotion first, whereas\u00a0investment\u00a0gets emotions out of the picture. You own these businesses, they\u2019re still sound, if the market doesn\u2019t think they\u2019re worth as much as they were, well, pity, the market doesn\u2019t know everything.\u201d \u2012 John \u201cJack\u201d Bogle, Founder and former CEO of the Vanguard Group<\/em><\/div>\n<\/blockquote>\n<p class=\"lt-biz-79465\">When the video was still available, we would show this segment in the face-to-face class and I would call out, \u201cWe do, Mr. Bogle! We do! We emphasize the distinction between investors and speculators\/traders in our Introduction to Investments class!\u201d The entire interview is over 30 minutes and highly informative and enterprising. Let\u2019s hope Forbes resurrects it.<\/p>\n<p class=\"lt-biz-79465\">Oh, by the way, Jesse Livermore, the famed\u00a0speculator\/trader, wound up heavily in debt and committed suicide. Please do not endeavor to become a\u00a0speculator\/trader. But if you do, we wish you the best of luck. You\u2019ll need it.<\/p>\n<\/div>\n<div id=\"section_3\" class=\"mt-section\"><span id=\"Observations_about_the_End_of_the_World\"><\/span><\/p>\n<h2 class=\"lt-biz-79465 editable\">Observations about the End of the World<\/h2>\n<p class=\"lt-biz-79465\">Some readers will ask, \u201cWell, what if\u00a0stock\u00a0prices all go to zero? What if the economy and the\u00a0stock market don\u2019t come back?\u201d This is a very probing question. It speaks to our justifiable fears about investing, especially in stocks. Let\u2019s rephrase the question: What if the world ends? The truth is someday the world is going to end. There are numerous scenarios. For example, we know that in about 1 or 2 billion years, the sun will expand and swallow Mercury and Venus and maybe even the Earth. However, it won\u2019t need to swallow the Earth for our world to end. By the time it gets to Venus, temperatures on the Earth will be hot enough to melt tin and lead and copper. Thankfully, we have a long time to prepare for this scenario. But what about all the other disasters looming on our horizon?\u00a0Global\u00a0warming, climate change,\u00a0income\u00a0inequality, nuclear war, rising sea levels, pandemics, tsunamis, earthquakes, fires, floods, disco returning!<\/p>\n<p class=\"lt-biz-79465\">As we said at the beginning, there will always be proclamations of doom and gloom, especially from charlatans ready to sell you their sure-fire method for surviving the end times. Don\u2019t listen to them! If the world does end, if our technologically based civilization cracks and falls and dissolves into a pool of tears, if there is no food at the grocery store, no gas at the gas station, no clothes at the mall, the cell phones aren\u2019t working, the utility companies are not pumping out electricity or natural gas, the trash isn\u2019t being picked up, the sewers are clogged, the hospitals, schools, fire departments, police stations, banks are all boarded up, etc., your\u00a0stock\u00a0portfolio will be the last thought on your mind. You will be digging for beetle grubs and boiling bark for dinner. Let\u2019s meet at the beach. You bring the marshmallows. I\u2019ll bring the vodka. We can get drunk and watch the world burn.<\/p>\n<p class=\"lt-biz-79465\">Take heart, Dear Students! This scenario is not going to happen! Failure is not an option! As I have already told you, Your Humble Author is firmly convinced that the next 20, 30, 50 years are going to be the most prosperous years in the history of our civilization. There is no doubt that we have tremendous hurdles to overcome, some might say they are insurmountable. But never underestimate the innovative power of our species. Just look at what we did with Covid in 2020. A vaccine usually takes at least 4 years and often up to 10 years to develop. Multiple groups around the world created safe and effective vaccines in a matter of months! We will overcome climate change. We will phase out fossil fuels. We will have driverless cars and some will be able to fly. We will cure cancer. We will colonize Mars. We will have universal language translators. We will have\u00a0domestic\u00a0robots. We will see the day when close to 100% of the citizens of our world are connected to the Internet. We will ensure that never again does disco become the dominant cultural icon of our nation! Economically, I am very confident of this and more. (Politically, I am very scared. Democracy is being attacked in many countries around the world, including the United States. But that discussion is for another class in another department. Thank goodness this isn\u2019t Kindergarten where all the disciplines are taught in the same classroom. Go take up our political woes with your Political Science professor.)<\/p>\n<\/div>\n<div id=\"section_4\" class=\"mt-section\"><span id=\"So_What_Is_a_Realistic_Rate_of_Return_for_Me.3F\"><\/span><\/p>\n<h2 class=\"lt-biz-79465 editable\">So What Is a Realistic\u00a0Rate of Return\u00a0for Me?<\/h2>\n<p class=\"lt-biz-79465\">After you have taken this course, you will have a strong foundation of the most popular types of securities investments: stocks, bonds, \u201ccash,\u201d and mutual funds. You will also know what levels of returns and what levels of risks you should reasonably expect to receive. And if you are a patient,\u00a0long-term\u00a0investor, I believe it is realistic to expect 8% to 10%. I am certainly working on it myself. So far, so good. Of course, as we will reiterate time and time again, there are no guarantees.<\/p>\n<p class=\"lt-biz-79465\">You are now most likely thinking, \u201c<em>But is 8% or 9% or 10% good enough for me?<\/em>\u201d It turns out the answer to this question is a resounding, \u201cYes!\u201d There are some caveats we need to add, though. If you start early, if you invest patiently and consistently, if you do not get cocky or greedy, if you do not chase after every \u201cNext Big Thing\u201d that comes along, and most importantly,\u00a0<em><strong>you do not panic when the market swoons,\u00a0<\/strong><\/em>as it inevitably will do from time to time, then \u2012 unless the world ends \u2012 we believe it is entirely reasonable and realistic to expect 8% or 9% or 10% over the long term. As mentioned, some investors have done better. The trick is to take advantage of the\u00a0<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/t\/timevalueofmoney.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>time value of money<\/u><\/a>, also known as the\u00a0<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/c\/cagr.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>compound annual return<\/u><\/a>\u00a0or the compound annual\u00a0growth rate. The time value of money is the amount to which a sum you invest now will increase based on a specified\u00a0rate of return\u00a0and time period. Calculating amounts into the future is called\u00a0<u><\/u>compounding<u><\/u>. The result is the\u00a0<u><\/u>future value<a class=\"link-https\" href=\"https:\/\/www.investopedia.com\/terms\/f\/futurevalue.asp\" target=\"_blank\" rel=\"external noopener nofollow\"><u>\u00a0of money<\/u><\/a>.\u00a0Future value\u00a0can be computed for a single amount, also known as a lump sum, a<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">principal, or a single payment.\u00a0Future value can also be determined for a series of deposits, also known as a stream of investments or an\u00a0annuity. (In our class, we usually don\u2019t use the term\u00a0annuity\u00a0because an\u00a0annuity\u00a0is also an insurance product. We discuss\u00a0annuity\u00a0insurance products at the end of the class. We do not have kind words for them.)<\/div>\n<p class=\"lt-biz-79465\">There is a\u00a0<u><\/u>future value<a class=\"link-https\" href=\"https:\/\/docs.google.com\/document\/d\/1_aLteHaZmC94VdDHl9vtOVIC0l0geVDmUV6auOlEinQ\/\" target=\"_blank\" rel=\"external noopener nofollow\"><u>\u00a0handout<\/u><\/a>\u00a0available on the\u00a0<a class=\"link-https\" title=\"https:\/\/wonderprofessor.com\/123\/\" href=\"https:\/\/wonderprofessor.com\/123\/\" target=\"_blank\" rel=\"external noopener nofollow\">class website<\/a>. We leave the calculations to you as an optional exercise.\u00a0Quite possibly you have already taken our Financial Planning and Money Management, now called\u00a0<a class=\"link-https\" title=\"https:\/\/wonderprofessor.com\/121\/\" href=\"https:\/\/wonderprofessor.com\/121\/\" target=\"_blank\" rel=\"external noopener nofollow\">Principles of Money Management<\/a>, class at Southwestern. We spend a good deal of time learning\u00a0future value\u00a0calculations in Principles of Money Management. At the very least, please review the\u00a0<a class=\"link-https\" href=\"https:\/\/docs.google.com\/document\/d\/16zBZ5rvydSxfuEot-UWv_Gr0AspslE2LgxQIiCnJtr0\/\" target=\"_blank\" rel=\"external noopener nofollow\"><u>answer key<\/u><\/a>\u00a0and listen to the\u00a0<a class=\"link-https\" href=\"https:\/\/wonderprofessor.com\/123s21\/Chap01\/Chap01_FutureValueCommentary.mp3\" target=\"_blank\" rel=\"external noopener nofollow\"><u>commentary<\/u><\/a>\u00a0to see the kinds of wealth that one can reasonably build over the working careers. We will also see some great examples in our next chapter on mutual funds. The news is good!<\/p>\n<p class=\"lt-biz-79465\">The\u00a0future value\u00a0calculations allow us to move from the present into the future. Later on, when we learn how to assign valuations to stocks and bonds, we will use the inverse of<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">future value,\u00a0<u><\/u>present value<u><\/u>, to move from the future back to the present. (\u201c<em>Huh? What?<\/em>\u201d Relax. Study what is in this chapter. We have a long road ahead of us.)<\/div>\n<p class=\"lt-biz-79465\">So are you ready to start your journey to become a prudent,\u00a0long-term\u00a0investor? Are you excited? I know I am! Well, before we get to the good stuff, we are going to take a small detour. We will now revisit\u00a0short-term\u00a0investments, vehicles that we use if we need the money in three, six, or nine months or even a year or two, depending upon the importance of the uses for the\u00a0short-term\u00a0funds.\u00a0Short-term\u00a0investments aren\u2019t very exciting. They aren\u2019t supposed to be. We don\u2019t want excitement with money that we need in the short term. We want certainty.<\/p>\n<\/div>\n<div id=\"section_5\" class=\"mt-section\"><span id=\".E2.80.9COh.2C_yeah.3F!_This_guy_says_I_can_earn_25.25_per_month!_Whaddya.E2.80.99_say_about_that.2C_huh.3F.E2.80.9D\"><\/span><\/p>\n<h1 class=\"lt-biz-79465 editable\">\u201cOh, yeah?! This guy says I can earn 25% per month! Whaddya\u2019 say about that, huh?\u201d<\/h1>\n<p class=\"lt-biz-79465\">Before we move on to\u00a0short-term\u00a0investments, we want to warn you again that there are plenty of con artists out there ready to take your money. Dear Students, if you are involved in the\u00a0investment\u00a0world for any period of time, eventually you are going to come across an advertisement, flyer, electronic mail or United States mail solicitation that promises eye-popping returns of 25%, 100%, 3,000% per year or even 300% or more per day.\u00a0Investment\u00a0scams have been with us forever. They will always be with us. Sadly, many uninformed individuals fall for their snake oil. Here is an example of one such outrageous claim:<\/p>\n<p class=\"lt-biz-79465\"><img decoding=\"async\" class=\"default\" src=\"https:\/\/lh3.googleusercontent.com\/8rQ1BB5nJQiUujkQNUWWiP-pXpjeq5npzWv8ENqHefsjBgBRbWMEfXksqTSFO1J7b6qcETxYLMuDt5sbKobXoVzPgAZ-SCVxkJpHnX-qtNeOMixrhHUeet9-5KwcueceBal-B0I7=s0\" alt=\"Scam artists plying his snake oil.\" \/><\/p>\n<p class=\"lt-biz-79465\">This advertisement was found on the Yahoo! Finance web site which is generally considered a reliable and reputable media outlook. Prepare to see far more outlandish and preposterous claims on less reputable locations. This guy is claiming that he was able to\u00a0<a class=\"link-https\" href=\"https:\/\/wonderprofessor.com\/123\/Chap01\/Chap01_Turn_33000_Into_7000000_In_2_Years.pdf\" target=\"_blank\" rel=\"external noopener nofollow\"><u>generate returns of 25% per month<\/u><\/a>. That is over 1,300% per year. This is total rubbish!<\/p>\n<p class=\"lt-biz-79465\">Oh, by the way, these advertisements are against the law. \u201cWhat?! Huh?! Don\u2019t we have freedom of speech in the United States?\u201d you ask. Well, yes, you are correct. We are free to express our viewpoints, opinion, and our understanding of the facts in the marketplace of ideas. But when it comes to<\/p>\n<div class=\"glossarizer_replaced\" aria-expanded=\"false\">investment<\/div>\n<p class=\"lt-biz-79465\">\u00a0advice and products, that freedom of speech is severely limited. So how do people get away with this? The Securities and Exchange Commission has a skeletal crew of regulators that can not begin to tackle this problem. They only go after the worst scoundrels. The same kind of illegal behaviors also go on in the\u00a0<a class=\"link-https\" href=\"https:\/\/nutritionfacts.org\/video\/are-weight-loss-supplements-effective\/?utm_source=NutritionFacts.org&amp;utm_campaign=40a90d1e8d-RSS_VIDEO_DAILY&amp;utm_medium=email&amp;utm_term=0_40f9e497d1-40a90d1e8d-27157657&amp;mc_cid=40a90d1e8d&amp;mc_eid=6b95979a51\" target=\"_blank\" rel=\"external noopener nofollow\"><u>world of weight loss supplements<\/u><\/a>. Some even sneak controlled, prescription-only drugs such as Prozac and Viagra into their products and some even put dangerous, banned chemical substances. Be careful out there, Dear Students!<\/p>\n<\/div>\n<footer class=\"mt-content-footer\">\n<hr class=\"autoattribution-divider\" \/>\n<div class=\"autoattribution\">\n<p>This page titled\u00a0<a class=\"internal mt-self-link\" href=\"https:\/\/biz.libretexts.org\/Bookshelves\/Finance\/Introduction_to_Investments_(Paiano)\/01%3A_Chapter_1\/01%3A_Introduction_Overview_and_Risk_versus_Return\/1.04%3A_Risk_versus_Return__The_Eternal_Struggle_of_Investing\" target=\"_blank\" rel=\"internal noopener\">1.4:\u00a0<\/a>Risk<a class=\"internal mt-self-link\" href=\"https:\/\/biz.libretexts.org\/Bookshelves\/Finance\/Introduction_to_Investments_(Paiano)\/01%3A_Chapter_1\/01%3A_Introduction_Overview_and_Risk_versus_Return\/1.04%3A_Risk_versus_Return__The_Eternal_Struggle_of_Investing\" target=\"_blank\" rel=\"internal noopener\">\u00a0versus Return \u2012 The Eternal Struggle of Investing<\/a>\u00a0is shared under a\u00a0<a href=\"https:\/\/creativecommons.org\/licenses\/by-nc-sa\/4.0\" target=\"_blank\" rel=\"nofollow noopener\">CC BY-NC-SA 4.0<\/a>\u00a0license and was authored, remixed, and\/or curated by\u00a0<a href=\"https:\/\/wonderprofessor.com\/\" target=\"_blank\" rel=\"nofollow noopener\">Frank Paiano<\/a>.<\/p>\n<\/div>\n<div id=\"librelens-attribution-list\"><\/div>\n<\/footer>\n<\/section>\n","protected":false},"author":33,"menu_order":5,"template":"","meta":{"pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-498","chapter","type-chapter","status-publish","hentry"],"part":485,"_links":{"self":[{"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/chapters\/498","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/wp\/v2\/users\/33"}],"version-history":[{"count":1,"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/chapters\/498\/revisions"}],"predecessor-version":[{"id":499,"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/chapters\/498\/revisions\/499"}],"part":[{"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/parts\/485"}],"metadata":[{"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/chapters\/498\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/wp\/v2\/media?parent=498"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/pressbooks\/v2\/chapter-type?post=498"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/wp\/v2\/contributor?post=498"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/accinvestments\/wp-json\/wp\/v2\/license?post=498"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}