Howdy Wall St. Willy! I keep hearing about risk and return whenever I read about investing. But what is risk return anyway?
Risk return is a theory in personal finance that talks about the relationship between risk and returns called risk return trade off or risk reward trade off. It says that generally the higher the risk, the higher the possible return is.
As a consequence, we can say that if someone wants to earn a higher return, they would need to take a higher risk, which means that they would need to be prepared for a higher possibility of losses.
Well, can you give me an example of that?
Sure, I can. Generally, stocks are more volatile and therefore are considered risky. So, investment in stocks has a potential for a higher return in the range of 7 to 8 % a year on average.
On the other hand, bonds are less volatile and are therefore considered less risky. So, investments in bonds has a potential for a lower return in the range of 2 to 3% a year on average.
Is this relationship between risk and return always true and does a high risk always give a higher return?
No. If a higher risk always gave a higher return, then it wouldn’t be a risk, right? A higher risk has a higher possible return, which means that the return can be high but it is not guaranteed.
Can a low-risk investment ever provide a higher return than a high-risk investment?
Yes. It is possible in the short term but highly unlikely in the long run.
Thank you very much for telling me about risk and return, Wall St. Willy.
You are welcome, Sooper Cooper. Remember, Finance is Your Friend!