Suppose a friend of yours comes to you with a “perfect” investment opportunity. “You can’t miss with this one,” your friend says. “There are no drawbacks, no downsides…it’s all good, man!” Evaluate your friend’s statements by discussing each of the following:
Identify the three qualities would this investment opportunity have to possess to be truly “perfect” and have “no downsides?”
Explain the trade-offs that you were taught in Unit 5 about those three qualities of investments.
Provide an example of a real-world investment and explain how the qualities of that investment illustrates that general rule.
Draw a conclusion about the truthfulness of what your friend is saying about this investment opportunity.
Three qualities that an investment opportunity would have to possess to be truly "perfect" and have "no downsides" are high returns, low risk, and liquidity.
High returns: An ideal investment opportunity would provide high returns on investment, allowing the investor to maximize their profits over time.
Low risk: A perfect investment opportunity would also have minimal risk associated with it, ensuring that the investor's principal is protected and they are not exposed to significant losses.
Liquidity: Lastly, an ideal investment would be easily liquidated, allowing the investor to access their funds quickly and without any major obstacles.
In Unit 5, we learned that there is always a trade-off between risk and return in investing. Generally, investments with higher potential returns come with higher levels of risk. Additionally, liquidity can also impact the potential return on investment, as assets that are more liquid may offer lower returns compared to illiquid assets.
An example of a real-world investment that illustrates this general rule is investing in treasury bonds. Treasury bonds are considered low-risk investments, as they are backed by the US government. However, the returns on treasury bonds tend to be lower compared to riskier assets such as stocks or corporate bonds. Additionally, treasury bonds are highly liquid, allowing investors to easily sell them if needed.
Based on the qualities of a "perfect" investment opportunity and the trade-offs between risk, return, and liquidity in investing, it is highly unlikely that such an opportunity exists. Therefore, it is important to critically evaluate any investment opportunity presented by a friend or advisor, as there are always potential downsides and trade-offs to consider. It is likely that your friend's claims about the investment opportunity being "perfect" and having "no downsides" are exaggerated or unrealistic.