Risk-Return Tradeoff


DEFINITION of 'Risk-Return Tradeoff'

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. According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost.


Loading the player...

BREAKING DOWN 'Risk-Return Tradeoff'

Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. Taking on some risk is the price of achieving returns; therefore, if you want to make money, you can't cut out all risk. The goal instead is to find an appropriate balance - one that generates some profit, but still allows you to sleep at night.

  1. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  2. Risk Profile

    An evaluation of an individual or organization's willingness ...
  3. Risk Curve

    A two-dimensional plot of real or projected financial harm/risk ...
  4. Casino Finance

    A slang term for an investment strategy that is considered extremely ...
  5. Return

    The gain or loss of a security in a particular period. The return ...
  6. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
Related Articles
  1. Mutual Funds & ETFs

    The Basics of How Mutual Funds Are Rated

    Learn how the major rating agencies assign mutual fund ratings. Understand what these ratings measure and how they are different from each other.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares Core High Dividend

    Discover how the iShares Core High Dividend ETF is managed, which index it tracks, and for whom it is most suitable as part of an overall portfolio allocation.
  3. Investing Basics

    5 Tips to Increase the Performance Of Your Portfolio

    Discover helpful steps an investor can easily take to improve the performance of his investment portfolio by maximizing gains and minimizing losses.
  4. Investing Basics

    Understanding Risk-Return Tradeoff

    The essence of risk-return tradeoff is embodied in the common phrase “no risk, no reward.”
  5. Investing Basics

    Achieving Optimal Asset Allocation

    Minimizing risk while maximizing return is any investor's prime goal. The right mix of securities is the key to achieving your optimal asset allocation.
  6. Investing Basics

    Determining Risk And The Risk Pyramid

    Many investors do not understand how to determine the risk level their individual portfolios should bear.
  7. Options & Futures

    5 Common Mistakes Young Investors Make

    Starting to invest can be a scary process. Luckily, steering clear of common errors is half the battle.
  8. Bonds & Fixed Income

    Why Stocks Outperform Bonds

    Why have stocks historically produced higher returns than bonds? It's all a matter of risk.
  9. Fundamental Analysis

    The Capital Asset Pricing Model: An Overview

    CAPM helps you determine what return you deserve for putting your money at risk.
  10. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  1. How can I use risk return tradeoff to determine my risk tolerance and investment ...

    An investor can use the risk-return tradeoff to determine what type of assets to include in a portfolio. The risk-return ... Read Full Answer >>
  2. Why is risk return tradeoff important in designing a portfolio?

    The risk-return tradeoff determines how aggressive an investor wants to be with the assets included in the portfolio. An ... Read Full Answer >>
  3. What are some classes I can take to prepare for the Series 6 exam?

    The risk-return tradeoff for bonds is the increased yield investors can obtain from corporate and other types of bonds that ... Read Full Answer >>
  4. What metrics should I use to evaluate the risk return tradeoff for a mutual fund?

    One of the principles of investing is the risk-return tradeoff, defined as the correlation between the level of risk and ... Read Full Answer >>
  5. How is the 80-20 rule (Pareto Principle) used in portfolios?

    The 80-20 rule generally holds that 20% of the holdings in a portfolio are responsible for 80% of the portfolio’s growth. ... Read Full Answer >>
  6. Are short-term investments a good strategy for cash-rich small businesses"?

    Before investing, small businesses should determine what they want to accomplish with short-term investments. Preserving ... Read Full Answer >>
  7. What is the best way to get exposure to electric cars when investing in the automotive ...

    Investors interested in electric cars have a variety of options. Automakers such as Tesla Motors exclusively manufacture ... Read Full Answer >>
  8. How do you interpret the magnitude of the covariance between two variables?

    Covariance indicates the relationship of two variables whenever one variable changes. If an increase in one variable results ... Read Full Answer >>
  9. What types of risk are incorporated in Security Market Line (SML) analysis?

    The security market line (SML) is a line plot that graphs an investment's risk versus its return. Essentially, it is a graph ... Read Full Answer >>
  10. How is the Capital Asset Pricing Model (CAPM) represented in the Security Market ...

    The capital asset pricing model (CAPM) is a measure that describes the relationship between the systematic risk of a security ... Read Full Answer >>
  11. Does 'hurdle rate' mean different things in different industries?

    The hurdle rate is defined as the minimum rate of return required on a project to cover costs and stay profitable. In different ... Read Full Answer >>
  12. How do I set a strike price in a put?

    The strike price of a put option is the price at which the option can be exercised. A put option gives the buyer, or holder, ... Read Full Answer >>
  13. Is there a positive correlation between risk and return?

    There is a positive correlation between risk and return with one important caveat. There is no guarantee that taking greater ... Read Full Answer >>
  14. Can an investor in the drugs sector buy companies that produce medicinal marijuana?

    Investors may purchase stock in companies producing medical marijuana products, or they may invest in the newly available ... Read Full Answer >>
  15. Why do high profiting sales mitigate credit risk?

    High profit sales reduce credit risk by providing a greater profit incentive in case the borrower is unable to pay the debt. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  2. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  3. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  4. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  5. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  6. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!