The Right Way to Look at Risk and Reward

by Manshu on May 31, 2009

in Links

Last week, Felix Salmon commented on a story that appeared on WSJ about a GM bondholder. He makes a very keen observation on risk and reward in that post.

If you invest a large chunk of your 401(k) in the stock of just one company, your actions are fraught with peril. If that stock performs badly — which is always possible — then you could end up with a significantly diminished standard of living in retirement. But at least there’s a possible upside: if the stock does spectacularly well, you can end up in clover.

By contrast, there’s no reason whatsoever to invest a large chunk of your 401(k) in the bonds of just one company. You still have the same downside — the company can default on its debt — but there’s no upside at all: the best-case scenario is just that you muddle through getting your coupon payments until the bonds mature.

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