Final answer:
In the context of CAPM, the optimal risky portfolio is subjective and based on an investor's preferences and goals. High risk has been detrimental in market downturns, but risky assets generally offer higher returns which is a key consideration for investors aiming for growth in their portfolios.
Step-by-step explanation:
In the context of the Capital Asset Pricing Model (CAPM), the term optimal risky portfolio does not have a standard definition as CAPM is typically concerned with the relationship between expected return and systematic risk of a security, represented by beta. The 'optimal' portfolio will inherently be subjective, as it greatly depends on an investor's risk tolerance and investment goals. Generally, the CAPM formula is used to calculate the expected return of an investment based on its systematic risk, compared to the risk-free rate and the market return.
The tradeoff between return and risk has historically proven to be a pivotal decision for investors. High risk levels have been detri mental to investment portfolios during market downturns, like the 1929 Great Depression, the 2008 Financial Crisis, and more recently during the COVID-19 pandemic market volatility. In these contexts, risky assets experienced significant losses while safer investments typically saw less negative impact.
Investors are encouraged to assess the tradeoff between return and risk in line with their personal preferences. While risky assets such as stocks offer higher average returns, they also come with a greater potential for loss. Conversely, safe investments like bank accounts offer lower returns but also come with minimal risk. The ideal investment choice should take into consideration an investor's financial situation, how much risk they can withstand, and the investment time horizon they are working with.