Different financial products, such as fixed deposits, bonds, stocks, or real estate, provide different returns. Why is the return different? To answer this, we must first understand the idea of risk. An important principle of investing is that higher expected returns are associated with higher risks. Risk determines the return on assets. Fixed deposit earns the lowest returns as it is considered the safest. Stocks have the highest expected returns because they are considered a risky investment. On average, a bond has a lower expected return than a stock because it is less risky, as is real estate, although there can be significant differences in riskiness between types of real estate.
But what is risk in terms of content?
There is no reward without risk in investing, and if an investment offers a higher expected return, it will generally be higher risk. And risk in content means the extent to which the actual income may differ from the expected one - i.e. volatility. Suppose an investment in commercial real estate has an expected annual return of 10%. If we rent better than expected, the actual return will be more than 10%. If we rent worse than expected, the actual return will be lower than 10%. The actual return will be 10% only if the investment in commercial real estate generates income as expected.
Risk means the uncertainty that expected returns may differ from actual returns. The possible range of this difference between actual and expected returns is risk or volatility.
A simple statistical measure of risk is the standard deviation of the expected return. The greater the deviation from the expected average, the greater the overall risk of the investment. If, on average, commercial real estate is more dependent on the economic state of the market than residential real estate, then returns on commercial real estate will be more volatile, although on average higher than what would be expected from the disappearance of apartments...
The ratio of expected return to risk is known as the Sharpe ratio. Rational investing aims to maximize the Sharpe ratio, which increases the return for the same risk or reduces the risk for the same return.
Additionally, to be successful in investing, you need to understand your risk appetite. Assess your risk appetite along three dimensions of need, ability and will, if you plan to retire at age 40, you will need to earn a higher income that will allow you to retire earlier. If you have dependent family members, your ability to take risks is lower than someone else who does not have dependent family members. If you have the need and ability to take risks, but the volatility after buying risky assets seems disturbing to you, then willpower is low. Think of investing like riding a roller coaster. If you choose too dangerous, you'll probably want to abandon the ride midway. Likewise, if you've made investments that are too volatile for your risk appetite, you may panic and sell them prematurely when the market temporarily slows. This will be a grave mistake. The key to successful investing is the ability and will to stay invested for the long term.