What is meant by the term 'risk-return tradeoff'?

The term 'risk-return tradeoff' refers to the principle that potential return rises with an increase in risk. This concept is fundamental in finance and investment, indicating that assets that have higher expected returns generally come with higher levels of risk. Investors must understand that to achieve greater returns, they often need to accept a higher degree of risk, which reflects the variability or potential volatility in investment outcomes.

For instance, investing in stocks often presents a higher potential return compared to more stable investments like government bonds, but it also carries greater risk, including the possibility of losing part or all of the invested capital.

Understanding the risk-return tradeoff allows investors to make informed decisions based on their risk tolerance, investment horizon, and overall financial goals. By acknowledging this tradeoff, individuals can better navigate their investment choices to strike an appropriate balance between risk and expected reward.