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!
Podcast: What is Risk Return Trade Off?
Fun, informative and concise episodes by a 10-year old, breaking down complex financial concepts in a way that kids and beginners can understand. Episodes cover personal finance topics like saving, investing, banking, credit cards, insurance, real estate, mortgage, retirement planning, 401k, stocks, bonds, income tax, and more, and are in the form of a conversation between a cowboy (a finance novice) and his friend, a stock broker. Making finance your friend, only at Easy Peasy Finance.
A little bit about me: I have been fascinated with the world of personal finance since I was 6! I love to read personal finance books, and keep myself updated on the latest by reading various personal finance magazines. My friends often ask me questions about finance because they find it complex and intimidating. That’s what inspired me to start my YouTube channel called Easy Peasy Finance when I was 8, and this podcast 2 years later.
Everything you need to know about risk-return: What is Risk Return, example of risk and return and risk-return trade off, is this relationship between risk and return always true, does a higher risk always give a higher return, can a low risk investment ever provide a higher return than a high risk investment, and more.
Show notes and transcript at: https://www.easypeasyfinance.com/what-is-risk-return/