What is the relationship between risk and return?

The relationship between risk and return is a fundamental principle in investment practice that indicates higher levels of risk are typically associated with the potential for higher returns. This concept is rooted in the risk-return tradeoff, which suggests that investors must accept more risk if they expect to achieve higher returns.

When considering various investment choices, those that are deemed riskier—such as stocks, especially in volatile markets—often have the potential for greater gains compared to safer investments like government bonds or savings accounts, which tend to yield lower returns. This risk-return dynamic provides motivation for investors to diversify their portfolios, balancing riskier assets with more stable ones to achieve desired investment goals while managing overall risk exposure.

This understanding of risk and return is crucial as it guides investment decisions and strategies, helping investors align their portfolios with their risk tolerance and financial objectives.