The essence of risk-return tradeoff is embodied in the common phrase “no risk, no reward.”  Risk is usually defined as the chance an investment earns something different from what is expected. The greater the actual earnings deviate from the expected earning, the riskier the asset is said to be.Each investor has her own risk tolerance.  Some investors are very conservative and thus not willing to accept much risk in their investments.  Other investors are very risk tolerant and can stomach a high level of risk, even to the point of losing their entire investment.  Return varies with the amount of risk an investor is willing to assume.  Typically, the higher the risk, the higher the return.  However, note that higher return means potential return, not guaranteed return.  A loss is just as possible, and can be just as big as the potential gain. Thus, investors try to strike a tradeoff between the two so that they can achieve the highest level of return for the lowest level of acceptable risk. The investment with the least amount of risk is considered to be United States Government Securities because there is virtually no chance of default. The interest rate on these securities is often referred to as the risk-free rate.  Thus, any return percentage above the risk-free rate is considered a risk premium, which is what the investor is willing to potentially be paid for accepting some risk.