One of the fundamental principles of the financial system is the trade-off between risk and return.
Risk can be thought of as the volatility of an investment or its potential for big movements (upward or downward).
Return is the percent change in an asset's value over time.
Simply, an investment that has higher risk should have higher returns.
Risk vs. Return in Asset Classes
Stocks (equities) often have higher returns but have the high potential to decrease in value. Bonds traditionally have lower returns, but carry less risk. Bonds can also decrease in value due to changes in interest rates or the issuer not having enough money to pay back who they lent it to!
Ultimately, all investment carries risk, but an informed investor knows what risks to take and when, balancing their own risk appetite with their investment horizon and investment goals.
Risk-Reward Tradeoff
|
Risk Level |
Reward/Return |
Investment Type |
What It Means for Investors |
|
High |
High |
Aggressive |
Appropriate for long-term growth; you have the time to ride out volatile market swings. |
|
High |
Low |
Unwise |
Taking on massive exposure to financial loss with almost no potential upside. Avoid these entirely. |
|
Low |
High |
Scam / Fraud |
Does not exist in legitimate finance. High guaranteed returns with zero risk is a major red flag. |
|
Low |
Low |
Conservative |
Perfect for protecting your capital and earning a predictable, steady baseline return |