Which statement best summarizes the relationship between risk and return?

The relationship between risk and return is a fundamental concept in finance, encapsulated well by the notion that higher risk typically allows for higher returns. This principle arises from the idea that investors demand a premium for taking on additional risk. When an investment carries a higher level of uncertainty or potential loss, investors expect to be compensated accordingly for that risk through potential higher returns.

In more stable investments, such as government bonds, the expected returns are relatively low because the risk of default is minimal. Conversely, investments in stocks or ventures with high volatility may offer greater potential returns due to the higher risk of loss. This dynamic encourages investors to weigh their risk tolerance against potential returns, guiding their investment decisions.

Understanding this relationship is critical for investors as it informs their strategies regarding portfolio diversification, asset allocation, and overall investment goals. Acknowledging that risk and return are correlated helps investors align their expectations and investment choices with their financial objectives.