Understanding Risk in Investing
Risk is, by far, the most crucial component of investing to consider, and it will be discussed throughout the remainder of this series…
Two Main Investment Options: Ownership vs Lending
We essentially have two alternatives when it comes to investing now:
- Becoming an Owner (Equity)
- Becoming a Lender (Debt)
Example: Investing in a Coffee Shop
Scenario Introduction
Assume that the neighborhood has a little, independent coffee shop…
The proprietor approaches you and presents you with two choices:
Option 1: Equity – Becoming an Owner
The first option is that he will offer you half of his business if you give him $100,000…
Understanding Stock and Equity Terms
- Equity
- Shares
- Stock
- Stock Shares
Option 2: Debt – Becoming a Lender
The second option is to lend the coffee shop owner $100,000 at a 4% annual interest rate for 10 years…
Key Terms
- Debt
- Bonds
- Fixed Income
Ownership vs Lending: Risk & Return Comparison
Best-Case Scenario (Ownership)
- Business becomes highly successful
- Your 50% share could be worth billions
Worst-Case Scenario (Ownership)
- Business fails and you lose the full investment
Best-Case Scenario (Lending)
- Earn $40,000 in interest and get full principal back
Worst-Case Scenario (Lending)
- Business fails after 7 years
- You receive $28,000 in interest and 50% of your $100,000 back
Moderate Scenarios: Realistic Outcomes
Moderate Success (Ownership)
- Business grows modestly
- Your 50% share might be worth $500,000 or less
Moderate Success (Lending)
- You receive all your interest and principal back
- Total return: $140,000
Key Takeaway: Risk vs Reward
- Equity (Stocks): High reward, high risk
- Debt (Bonds): Lower reward, but safer
“Higher returns come with higher risk”
Final Notes
This overview explains the basic differences between stocks and bonds. In the next part of the series, we will explore how these investment options combine to form a diversified investment portfolio.
