B<\/span>ack in lesson one<\/a>, we looked at the main reason why we invest our money \u2013 which is to retain its spending power.<\/p>\n By keeping our money in a cash savings account and retaining the interest it generates over time, we can hope to at least keep up with inflation<\/a>.<\/p>\n Hurrah! We\u2019re not getting any poorer.<\/p>\n But we\u2019re also not getting richer:<\/p>\n Super-investors like Warren Buffett<\/a> didn\u2019t become multi-billionaires by saving into cash accounts.<\/p>\n In fact, it\u2019s very hard to even retire comfortably if all we do is match inflation with our savings.<\/p>\n You need a savings pot of roughly \u00a3500,000 to generate an income of around \u00a320,000 a year.<\/p>\n Let\u2019s imagine you\u2019re 40. You want to retire at 65, and you already have \u00a3100,000.<\/p>\n You can quickly calculate<\/a> you might need to save at least \u00a310,000 every year into your cash account to reach your \u00a3500,000 target in today\u2019s money.<\/p>\n (Your pot by 65 in this example would be around \u00a3700,000. But remember: inflation will have eroded its spending power. So we\u2019re assuming that \u00a3700,000 will only buy what \u00a3500,000 gets you today.)<\/p>\n Finding \u00a310,000 a year in cash to save is very hard for most people. (It\u2019s easier when using a pension<\/a>, especially if your employer contributes.)<\/p>\n Ideally we want our money to work much harder to generate more of what we\u2019ll need to enjoy a comfortable retirement.<\/p>\n The good news is there are plenty of other places we can put our money to work besides cash.<\/p>\n Examples: Corporate and government bonds, shares (equities), property, and gold.<\/p>\n The bad news is all of these options introduce new risks<\/strong> that we must take in order to have a shot at the potentially higher rewards<\/strong> they offer.<\/p>\n Cash<\/a> is the only completely safe investment<\/strong> \u2013 and even it faces risks like bank crashes<\/a>, or the risk that the interest we\u2019re paid is inadequate to keep up with inflation.<\/p>\n Like a lot of investing, talk of risk and reward (i.e. the return you make on your money) can sound off-putting<\/p>\n But actually you\u2019ll already understand the basics.<\/p>\n That\u2019s because there are lots of different kinds of risk\/return situations in everyday life:<\/p>\n Investing risk similarly comes in different shapes and sizes.<\/p>\n Remember the smooth graph of returns from cash we saw in lesson one?<\/p>\n Let\u2019s call it Graph A:<\/p>\n Every year we have more money than before. That\u2019s ideal, surely?<\/p>\n Well, compare it to the value of our investment over time in Graph B below \u2013 and pay attention to the \u2018Y\u2019-axis:<\/p>\n Graph B shows a much riskier investment. Risk here is synonymous with volatility \u2013 the value of this investment goes up (yay!) but also down (boo!)<\/p>\n You can see we even fell below our initial starting point for a while, before eventually coming good.<\/p>\n We endured this volatility for higher returns.<\/strong><\/p>\n Things would have been very different if we\u2019d cashed out early in year seven. We\u2019d be down 40% on our starting capital.<\/p>\n That\u2019s important: even when you invest for the long term, taking risks isn\u2019t guaranteed to pay.<\/p>\n Introducing Graph C:<\/p>\n This time things started well, but in year 13 disaster struck. We lost the lot!<\/p>\n (How? Perhaps we invested in a failed company like WeWork or Northern Rock, or a buy-to-let apartment that burned down without insurance.)<\/p>\n These various graphs reveal two key risks<\/a> when investing:<\/p>\n Which of the following three investments do you prefer?<\/p>\n The sensible answer is to prefer Investment One to Investment Two. Why put up with sleepless nights from volatility for no extra reward in the end?<\/p>\n Investment Three might be worth it, provided you can take the volatility. But what if there\u2019s a 10% chance of Graph C \u2013 a total wipeout?<\/p>\n And there\u2019s the final snag. We don\u2019t know<\/strong> what the graphs will look like in advance.<\/p>\n Hence we can never be sure how our returns will play out<\/a> until the end.<\/p>\n Almost all investing decisions boil down to this interplay of risk and reward.<\/p>\n If something looks too good to be true<\/strong>, then you are probably not seeing all the risks<\/strong>.<\/p>\n We\u2019ll see as we go through this series<\/a> that the best way to manage these risks is to diversify your money across different kinds of assets, to reflect your personal attitude<\/a> towards risk and investment<\/a>.<\/p>\n This is one of an occasional series on investing for beginners<\/strong>. Subscribe<\/a> to get all our articles by email and you\u2019ll never miss a lesson!<\/em> Why not tell a friend<\/a>?<\/em><\/p>\n\n
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Please sir, can I have some more?<\/h4>\n
Desperately seeking a better return than cash<\/h3>\n
Risk and return 101<\/h4>\n
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Risk and return three ways<\/h4>\n
![\"2.cash-return-time\"](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2013\/07\/2.cash-return-time.jpg?resize=520%2C339&ssl=1\")
<\/a><\/p>\n![\"2.volatile.return\"](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2013\/07\/2.volatile.return.jpg?resize=520%2C331&ssl=1\")
<\/a><\/p>\n![\"2.investment-goes-to-zero\"](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2013\/07\/2.investment-goes-to-zero.jpg?resize=520%2C386&ssl=1\")
<\/a><\/p>\nRisk versus reward<\/h3>\n
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Key takeaways<\/h3>\n
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