Risk-Return Trade-Off

The concept that the higher the return or yield, the larger the risk; or vice versa. All financial decisions involve some sort of risk-return trade-off. The greater the risk associated with any financial decision, the greater the return expected from it. Proper assessment and balance of the various risk-return trade-offs available is part of creating a sound financial and investment plan. For example, the less inventory a firm keeps, the higher the expected return (since less of the firm's current assets is tied up). But there is also a greater risk of running out of stock and thus losing potential revenue. In an investment arena, you must compare the expected return from a given investment with the risk associated with it. Generally speaking, the higher the risk undertaken, the more ample the return; conversely, the lower the risk, the more modest the return. In the case of investing in stock, you would demand higher return from a speculative stock to compensate for the higher level of risk. On the other hand, U.S. T-bills have minimal risk so a low return is appropriate. The proper assessment and balance of the various risk-return trade-offs is part of creating a sound investment plan.