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Chapter 6. Foolish Risks > The Right Risks

The Right Risks

Investment theory suggests that risk and return are related. The more risk you take, the more return you should require. If you are not rewarded for taking risk, then you should only buy Treasury Bills and other guaranteed investments that have no risk. Why do you buy securities that have some risk? Because they offer a higher return. Bonds have more risk than Treasury Bills, and thus, offer a higher return. Stocks have more risk than bonds, so they offer an even higher return. This risk–return relationship appears reasonable.

However, on average, you do not get rewarded for every risk you take. For example, if you go to Las Vegas and play the slot machines, you are taking risk. The payoff of slot machines favors the casino. On average, slot machine players lose more than they win. They are not rewarded for taking risk. In the investment world there are risks you get rewarded for taking and risks you are not rewarded for taking.


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