What does the risk-return relationship imply?

The risk-return relationship is a fundamental principle in finance that indicates how potential returns on investments relate to the amount of risk taken. The correct answer suggests that as the level of risk increases, the potential return on an investment also increases. This means that investors who are willing to take on more risk typically expect to receive higher returns as a reward for that risk.

This relationship underscores the importance of evaluating one’s risk tolerance before investing. For example, higher-risk assets such as stocks or startup investments can generate significant profits, but they also come with the possibility of substantial losses. Conversely, lower-risk investments like government bonds typically provide more stable returns but at lower rates.

Understanding this relationship guides investors in making informed decisions about their portfolios, balancing risk with potential returns to align with their financial goals.