Risk Versus Reward of Investments

If you have some extra cash and are looking to invest your money, the expected amount you can earn is often the result of the amount of risk you take with your money. If you want a guaranteed return, such as a government bond or a bank CD, then the return will often be fairly low but you will also not have very much risk. In contrast, you can potentially make a lot of money in the stock market, but you may lose a lot as well.

When it comes to guaranteed returns like bank certificate of deposits, the amount of time you lock up your money will influence your rate of return. Banks will generally pay a higher interest rate on a thirty year CD than a 6 month CD. There are a few instances when this isn't the case, when the interest paid is about the same. But in general, the longer the lock-up period, the higher the rate. This is especially the case during a recession when people are in need for cash. Currently, banks will pay much more for a thirty year CD than a six month one. Most of the time, the interest you get on a CD will range from 2-5%, depending on how long you lockup your money and the prevailing interest rates at the time.

The opposite of a bank CD is investing in the stock market. Over the long run, you will generally make more money by putting your money in stocks than a guaranteed return like a CD. However, the volatility can be great. For example, in 2008, the stock market is down nearly 40%. So for every $100 you invested in the market at the beginning of the year, you just have $60 now. However, some years the market earns 10-20% or more. Most of the time, the stock market goes up. But it can have brutal years like this one when people lose tons of money.

A sort of middle-of-the-road approach towards investing is buying corporate bonds. This is where you essentially loan money to a corporation. When you buy stock in a company, you are buying a small ownership stake in the company. However, when you buy a bond, that just means you are loaning the company money. Corporate bonds generally pay more than bank corticated of deposits, though they generally make less than the stock market itself over the long run.

Bonds carry less risk than stocks but do have some risk. After all, the company needs to be able to repay your loan. If you buy the bond of a startup company or a company in trouble, you stand to earn more because the rate will likely be higher, but there is the greater risk that the company may not be able to pay you back. In contrast, a well-established company that is clearly profitable and does not have too much debt will likely pay a lower rate.