Risk, Return, And Diversification

What you will learn

• Understand that higher expected returns almost always come with higher short term volatility, and that the 'risk' in risk-return is usually about short term ups and downs rather than total loss.
• Understand why owning many different things at once reduces overall risk without reducing expected return by the same amount, and why diversification is often called 'the only free lunch in investing'.
• Understand why fees and costs matter enormously in long term investing and why low cost funds almost always beat high cost funds over long periods.
• Combine the ideas of risk-return, diversification, and low cost to sketch a Simple Portfolio for a realistic long term investor.

What happens in this lesson

1. Chapter 1: Risk And Return

   Understand that higher expected returns almost always come with higher short term volatility, and that the 'risk' in risk-return is usually about short term ups and downs rather than total loss.

   What you make: A saved risk note ranking three familiar investment options from lowest to highest expected return and explaining what kind of risk goes with each.

2. Chapter 2: Diversification

   Understand why owning many different things at once reduces overall risk without reducing expected return by the same amount, and why diversification is often called 'the only free lunch in investing'.

   What you make: A saved diversification note explaining why spreading money across many different companies is less risky than concentrating in one or two, using a specific example.

3. Chapter 3: Costs And Fees

   Understand why fees and costs matter enormously in long term investing and why low cost funds almost always beat high cost funds over long periods.

   What you make: A saved cost comparison note showing the difference between a high fee and a low fee fund for a specific investor over 30 years.

4. Chapter 4: Simple Portfolio Sketch

   Combine the ideas of risk-return, diversification, and low cost to sketch a Simple Portfolio for a realistic long term investor.

   What you make: A saved Simple Portfolio Sketch showing a diversified, low cost mix of investments for a specific realistic investor, with rough allocations and a one line rationale.

5. Chapter 5: When The Plan Changes

   Adapt a simple portfolio to a new real constraint and explain the tradeoffs between risk, return, diversification, and cost.

   What you make: A saved portfolio revision note showing how one original Simple Portfolio Sketch changes for a new investor situation, with a short explanation of what changed and why.

Key terms in this lesson

• Asset Allocation

  The percentages of a money collection placed into different types of holding.

• Bond

  A loan to a government or company that promises payments under stated terms, while still carrying a chance of loss.

• Concentration Risk

  The chance of a large loss because too much depends on one company, place, industry, or event.

• Diversification

  Spread money across different things so one bad result does not sink the whole pile.

• Expected Return

  An estimate of what a choice might earn across many possible outcomes, not a promised result.

• Goal Shortfall Risk

  The chance that the money available on the goal date is less than the amount needed.

• Gross Return

  The gain or loss measured before fees and other stated charges are taken away.

• Index Fund

  A fund that follows a set list of holdings instead of asking a manager to choose each one.

• Inflation

  When prices rise across an economy over time, your money buys less than it used to, even though the number stays the same.

• Investment

  Putting money into something you expect to grow or pay you over time, accepting that you might also lose some of it.

• Investment Fee

  Money charged for buying, selling, running, or advising on a financial product.

• Liquidity Risk

  The chance that you cannot turn something into spendable money quickly without accepting a lower price.

• Permanent Loss

  Money that is not recovered because something fails, becomes worthless, or is sold for less and never bought back.

• Portfolio

  The complete group of financial holdings one person or organisation owns.

• Realised Return

  The gain or loss that actually happened over a stated period after the result is known.

• Return

  The gain or loss from an investment over a stated period.

• Risk

  The chance that a money choice will not provide what you need when you need it.

• Risk and Return

  A higher possible gain usually comes with more uncertainty or a greater chance of loss, but the gain is never owed.

• Time Horizon

  The length of time before you expect to need the money.

• Volatility

  How sharply a price moves up and down over a period.