If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content

Course: Financial Literacy > Unit 7

Lesson 2: Risk and return of investment options
Life skills
Financial Literacy
Investments and retirement
Risk and return of investment options
© 2024 Khan AcademyTerms of usePrivacy PolicyCookie Notice

Investing: Risk and return

Google Classroom
Risk and return are two important concepts to understand when it comes to investing. Different types of investments have different levels of risk and return, and investors should choose options that match their goals and risk tolerance.

What is risk and return in investing?

When you decide to invest your money, there are two important things to consider: risk and return.
Risk is the uncertainty or variability of the outcome of an investment. In simpler words, it means that there's a chance your investment may not make as much money as you hoped, or you could even lose some or all of your investment.
Return, on the other hand, is the gain or loss from an investment over a period of time. It tells you how much money you made, or lost, on your investment. If you have a positive return, that means your investment has made money. If your return is negative, then you have lost money.

How are risk and return related?

Risk and return are related because generally, the more risk you take with an investment, the higher the potential return. But, taking more risk also means more potential for loss.
Factors that influence risk and return include the type, quality, and duration of the investment, the market conditions, and the investor's behavior. For example, if you invest in a company with a strong track record, your risk might be lower, but so might your return. On the other hand, if you invest in a new company with an unproven track record, you could make a lot of money if the company succeeds, but you also risk losing your entire investment if the company fails.
two arrows, both pointing up. Left arrow reads "risk", right arrow reads "return".
The higher the risk an investor is willing to take, the higher the potential return they can expect on their investment.

Risk: How can I tell how risky an investment is?

We group investments into three categories: low risk, high risk, and moderate risk and return. It is hard to know how well an investment will do, but there are some general groups we can put them into:
  • Low-risk, low-return investments: Treasury bills are an example of this type of investment. They are issued by the government and are considered very low-risk, but they also offer lower returns compared to other investments.
  • High-risk, high-return investments: Penny stocks are an example of this type of investment. These are stocks of small companies that trade at very low prices. They can offer huge returns if the company does well, but they also carry a higher risk of loss.
  • Moderate-risk, moderate-return investments: Index funds are an example of this type of investment. These are funds that aim to match the performance of a specific market index. They offer diversification and generally have a lower risk than individual stocks, but they can still offer decent returns.
As you can see, we do not have a low-risk, high return (everyone would invest into that) or high-risk, low-return (why would anyone invest into that?). So, remember, risk and return always go hand-in-hand - when one is low, so is the other one, and vice-versa.
Risk & returnTypes of investment
Low-risk & low-returnmoney markets, treasury bills, bonds
Moderate-risk & moderate-returnmutual funds, index funds
High-risk & high-returnstocks, cryptocurrency,

Return: Return on investment (ROI)

Imagine you have $100 to invest in something. You know that if you make a good choice, you can turn that $100 into even more money. This is where ROI, or Return on Investment, comes in. ROI helps you figure out how much money you've made from an investment compared to how much you put in. So, if you invested your $100 and it turned into $150, your ROI would be 50%. That means you made 50% more money than you started with.
Knowing how to calculate ROI can help you decide where to put your money, whether it's a company stock, a business, or even a college savings account. Smart choices today can lead to big rewards tomorrow.
To calculate the return on investment (ROI) for an investment, you can use this simple formula:
ROI=Current value of investment− Initial investmentInitial investment×100
For example, if you invested $1,000 in a stock and it is now worth $1,200, your ROI would be:
ROI=$1,200−$1,000$1,000×100=20%
This means that you made a 20% return on your investment.
But, also, if you invested $1,000 in a stock and it is now worth $900, your ROI would be:
ROI=$900−$1,000$1,000×100=−10%
Is this a good return?
Choose 1 answer:

A lot of the time, you can find the ROI for different investments online. So, you don't have to do any math. This is helpful when you're trying to decide what to do with your money, like buying stocks or investing in general.
But sometimes, you can't find the ROI on the internet, or you're starting your own business. In that case, it's important to know how to calculate ROI on your own.

Rule of 72

Now that we know what ROI is, we can take investment planning one step further - into the future!
For this, you need the Rule of 72. The Rule of 72 is a simple math formula that helps us estimate how long it will take for our money to double when we invest it. All we have to do is divide the number 72 by the interest rate or ROI. The answer we get tells us approximately how many years it'll take for our money to double.
For example, if we invest our money and earn an interest rate of 6%, we would do this: 72÷6=12 years. So, it would take about 12 years for our money to double.

Why is the Rule of 72 useful?

The Rule of 72 is helpful because it shows us the power of investing and how our money can grow over time. When we invest, we want our money to grow and make more money for us. By using this simple rule, we can quickly see how long it will take for our money to double at different interest rates.

How can we use the Rule of 72 with ROI?

Remember, ROI helps us figure out how much money an investment makes. We can use the Rule of 72 together with ROI to see how our money should behave in the future.
For example, imagine you invest $500 into a mutual fund with an 8% ROI. You completely forget about it, and about 9 years later you check the account and find out that it grew to $1,000.
In 9 more years, it will become $2,000, and in 9 more $4,000! And it will keep doubling, as long as the ROI, or the interest rate remains around 8%.
Check your understanding
If you put $1,000 into a mutual fund that grows at 9% each year, how long until you have $4,000?
Choose 1 answer:

Conclusion

In conclusion, investing is one way to grow your money and reach your goals faster. Remember, higher risks often lead to higher returns, but it's important to be smart about it. Keep the Rule of 72 in mind to quickly estimate how long it'll take to double your investment. Next, start learning about investment options and make your money work for you, as you step into the world of financial growth and success.

Want to join the conversation?

Log in