The risk-return trade-off is a concept that every investor should be familiar with. Stated simply, it means that to gain a higher potential return on an investment, you have to accept more risk. It’s also important to understand what those risks might be, like the risk of losing some of your capital, the risk of fluctuating returns, or the risk involved in holding cash in the bank as inflation eats away at the value of savings.
You can’t avoid risk, it’s inevitable. The trick for the canny investor is to manage it carefully, by creating an investment portfolio with a risk profile that matches their needs. Of course the needs of different individuals can vary enormously. A 59 year-old hoping to retire at 60 probably won’t be willing to risk the capital in their pension pot, so they may choose to accept a lower return in exchange for greater security. While a 25 year-old with far less capital may be willing to accept much higher risk in the hope of benefiting from higher growth.
There’s also individual “appetite for risk” to consider. But of course it’s not actually the “risk” that people hunger after, it’s the potential rewards – and investors should think carefully about what they’re willing to put on the line before they go chasing them.
