Reward and Risk

There is a positive correlation between reward and risk. The higher the risk the higher the reward and the lower the risk the lower the return. We can pursue high risk investments and hit it big. But if we are wrong we can be wiped out. That is why it is important to diversify.

Imagine owning shares of different companies on the stock market. If all your shares are held in one company and that industry collapses you are doomed. So if you hold only stocks in one airline and all flights are cancelled because of COVID you are going to make huge losses. 

Ideally you want to own investments which are not directly correlated with each other. For a given expected return the risk reduces with the number of uncorrelated assets you add to the portfolio. So a diversified portfolio generally has a lower risk to return ratio. 

Try and diversify across industry, time, country, currency, market and asset class. This way you avoid being wiped out in case things really go bad. Warren Buffet says that the first rule of investing is not to lose money. And the second rule is not to forget the first one.

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