The concept of risk-return trade-off is a fundamental principle in finance, which states that the potential return an investor expects to receive from an investment is directly proportional to the level of risk involved. This means that the higher the risk associated with an investment, the higher the expected return should be to compensate for that risk.
The reason for this is that investors are not willing to take on higher levels of risk without the promise of higher potential rewards. For instance, if an investor wants to invest in a low-risk investment like a savings account, they can expect a relatively low return. In contrast, if they invest in a high-risk investment such as a start-up company, they can expect a higher potential return, but also a higher level of risk.
The risk-return trade-off principle helps investors to determine an investment's expected return based on its level of risk. When making investment decisions, investors must consider their tolerance for risk and their investment goals. If an investor has a low tolerance for risk, they may opt for low-risk investments, even if the expected return is lower. Conversely, if an investor has a high tolerance for risk, they may opt for high-risk investments, even if the expected return is higher.
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