So risks and diversity reward and diversification,,

these are some of the most important concepts that we

need to understand before we start our portfolio.

There are factors that come into play in all investment decisions.

Investors need to learn a little bit more than

just the textbook definitions of these factors.

And you need to understand how they, in conjunction with

market timing and business cycles, affect portfolios.

Even risk, when properly managed and

understood, can even help your portfolio.

And there are different levels of risks and different types of diversification.

Simply put, risk is the term that is used to determine the volatility or

the uncertainty of your investment results.

So this typically goes hand in hand with returns.

The more risk you take, more often than not, the higher is the expected return.

Conversely, the lower the risk you take, the lower the risk of the return.

When we say return, it generally means profit.

In the investing world it's usually expressed as a percentage and

is often annualized.

For instance, if you're investing $100 and

getting a $6 profit in, say, a couple of years, you have a return or

profit percentage of 6% and an annual return of 3%.

If you're investing $100 and making, let's say, a $50 profit over two years,

that's 50% return over two years and an annual return of 25%.

To understand, that was return, so let's understand risk now and risk tolerance.

So to understand risk tolerance,

let's look at a very simple example that I often give to my friends.

Let's say there are four friends, a, b, c and d, and let's put some name for that.

Let's call them A for Adam, B for Bob, C for Charlie and D for David, okay.

And let's say each of them have very different ways of investing their money.

And let's say each of them have $100 in their pocket and

they want to invest it in their own ways.

And they invest differently because they have very different

levels of risk tolerance.

So let's say Adam is extremely risk averse, and

keeps his $100 in his pant pocket or keeps his cash in an old jam jar.

I mean, he sleeps very soundly knowing that he will always have

$100 in the jar because it can't go anywhere.

Then you have Bob who is also risk averse but he deposits his $100 in,

let's say, a money market account at the biggest bank, the oldest bank in town.

And that money market account pays, say, 1% and

Bob is positive in 12 months and

he'll have essentially 1% on $100 which is, he'll have $101 in that account.