Session 7 Risk vs return, compounding, time value of money
What Is Risk?
Risk is the possibility that an investment’s actual return will differ from what you expect — including the possibility of losing money.
Types of risk:
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Market risk (prices fluctuate)
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Inflation risk (money loses purchasing power)
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Business risk (company underperforms)
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Liquidity risk (can’t sell quickly)
What Is Return?
Return is the profit (or loss) you earn on an investment.
It can come from:
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Capital appreciation (price increases)
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Income (dividends, interest)
Return is usually expressed as a percentage.
The Risk–Return Relationship
In investing, there is a general rule:
Higher potential return usually comes with higher risk.
Compounding: The Power of Growth
Compounding is when your earnings start generating their own earnings.
Simple Example
If you invest $1,000 at 10% annually:
Year 1 → $1,100
Year 2 → $1,210
Year 3 → $1,331
You earn returns on both:
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Your original money
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Previous returns
That’s compounding.
Why Time Matters
The longer you stay invested, the more powerful compounding becomes.
Small amounts invested early can outperform large amounts invested later.
This is why starting early is one of the biggest advantages in investing.
Time Value of Money (TVM)
Core Idea:
A dollar today is worth more than a dollar in the future.
Why?
Because money today:
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Can be invested
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Can earn returns
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Has more purchasing power
Future Value Concept
Future Value (FV) calculates what today’s money will grow into.
Formula:
FV = PV × (1 + r)^n
Where:
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PV = Present Value
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r = Interest rate
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n = Number of years
Present Value Concept
Present Value (PV) calculates what a future amount is worth today.
Formula:
PV = FV ÷ (1 + r)^n
This is how investors decide whether an investment is worth it.
How These 3 Concepts Connect
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Risk determines the return you demand.
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Return drives compounding.
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Time makes compounding powerful.
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Time value of money helps you compare money across time.
Together, they form the foundation of all investing decisions.