Final answer:
The basis of an investment policy should not include unreasonable risks that are inconsistent with the investor's goals and risk tolerance. Historical events like the stock market crash of 1929 exemplify the consequences of high-risk investment strategies. A balanced approach between expected high returns and associated risks is essential for a sound investment policy.
Step-by-step explanation:
The basis of an investment policy should not include unreasonable risks that are not aligned with the investor's goals and risk tolerance. Throughout history, times of high risk investments have often led to detrimental outcomes for investors or even broader economic consequences. For example, the stock market crash of 1929 was largely due to excessive risk-taking with borrowed money, leading to a devastating economic depression. Similarly, the dot-com bubble burst and the 2008 financial crisis are other instances where high-risk investment strategies significantly affected portfolios and economies. Reasonable risk implies that an investor seeks a balance between potential returns and potential losses, ensuring that they are not exposed to losses that exceed their capacity to recover or that do not match their investment objectives.
When investors mix up the concepts of risk and return, they might misunderstand the nature of their investments. A healthy investment policy observes the principle that with expected high returns, there tends to be a corresponding level of risk. Investors should aim for an investment policy that aligns their portfolio with their long-term financial goals, taking into account risk tolerance and expected returns without being lured by the unlikely promise of high returns from high-risk investments. Hence, an investment policy should be based on a well-considered balance of risk and return rather than the pursuit of unreasonable risk.