14 August 2008
The principle that potential return rises with an increase in risk. Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. In other words, the risk-return trade-off says that invested money can render higher profits only if it is subject to the possibility of being lost.
Notes: Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. But, taking on some risk is the price for achieving returns, so, to make money, you can't cut out all risk. The goal instead is to find an appropriate balance, one that lets you sleep at night but still generates some profit. Furthermore, you want to maximize your potential return for the risk you take on, and a good asset allocation one means to doing so.
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