Relationship between Risk, Profitability and Temporary Horizon

The risk and temporary horizon are closely related and form two substantial elements to be considered when constructing investment portfolios. The profitability of the portfolio will be consequence of these two variables: of the risk that is assumed throughout the temporary horizon.

In general, there is the following relationship:

• The longer the temporary horizon, the more risky will be the investment portfolio, because in the long-term investment, the probability of obtaining negative results is reduced, until becoming almost non-existent. The higher the risk of an investment portfolio, the greater will be its expected return. In other words, for long temporary horizons, portfolios may be constructed with more risk, that result in a higher expected profitability.

• Following the above reasoning, in cases where the temporary horizon is short, more conservative investment portfolios should be constructed; in other words, with lower risk. The lower the risk of an investment portfolio, the lower will be its expected return.

Therefore:

• If an investor wants to obtain a high mean return in time, he must assume risk, and allow time to work for him.

• If an investor does not have time (short temporary horizon) he must assume low risk and consequently the return will be limited.

• If a person cannot assume a long temporary horizon or does not want to contract risk, he might not obtain a high return.

To illustrate these concepts, an example is given comparing two investment funds with different risk.