ABSTRACT
This chapter distinguishes between the investor, the gambler and the speculator. It examines the different sources of investment return. The important concept of risk is introduced and what risk means to different investors is explored. The concept of risk as defined and measured by Markowitz is examined, and is extended to the implications for portfolio construction. Each investor reacts in different ways to changes in the economic and investment environment, depending upon a variety of factors, including, amongst others: time horizons; income requirements; the tax and regulatory regime to which they are subject, etc. Investment theory assumes that all investors are rational, but experience shows that emotions (fear and greed) play a big role in investor behaviour. Investment risk is multifaceted and there are many types of risk, including: systemic risk; specific risk; counterparty risk; default risk, etc. Volatility – the extent to which returns fluctuate around their historical average – has become the standard measure of risk.
