Understanding Risk-Return Trade-off: Why It Really Matters?

Many investors are indecisive about putting their money in markets that entail higher risks. They would rather save their bank earnings and let them grow with small interests. But is that a good decision? The truth is, you might be losing the biggest opportunity of your life. 

Investments might involve risks, but that also means substantial returns when you hit your targets. Unlike saving money in the bank, you can avoid currency devaluation, which is a threat. All you have to do is play by the rules, making sure you do everything to earn returns. 

How are you going to do that? Start from the fundamentals until you work your way through the top. There are crucial things that you should know as a beginner. One of them is understanding the risk-return trade-off, which would make you a smart investor. 

You can apply the principles of the concept when you join the cryptocurrency market. You’re probably familiar with the volatility and unpredictability of this business, but that’s where the catch is. The higher the risks, the more promising the potential returns. Read on and learn about the risk-return trade-off, which is important for you as a trader or investor. 

What’s All About Risk-Return Trade-off?

For example, you can look at risks differently – as a challenge to overcome. This can develop the right mindset toward investing, that’s generally about taking risks to earn returns. That’s what essentially defines the risk-return trade-off stating that the potential return rises with an increase in risk

Under this principle, it’s logical to say that low uncertainty levels also mean the minimal potential for returns. Conversely, the opportunity to grow assets is very significant when the risks are high. In other words, it offers a huge opportunity when you accept a higher possibility of losses. 

Remember, though, that the appropriate risk-return trade-off depends on various factors, such as:

  • your risk tolerance
  • available budget
  • time or remaining years before retirement chances of replacing lost funds
  • determining a portfolio with the appropriate levels of risk and reward; 

If you can invest in assets over the long term, that gives you the potential to recover from the risks of bear markets and get involved in bull markets. While if you can only invest in a short time frame, you face the same higher risk proposition.

Generally, many investors use the risk-return trade-off as an integral part of each investment decision and assess their portfolios. At the portfolio level, the risk-return trade-off may include assessments of the diversity or concentration of assets and whether the mix entails too much risk or has a lower potential for returns.

How to Measure Individual Risks? 

When you decide to enter a highly risky business environment but with promising gains, you may apply the risk-return trade-off to the vehicle on a singular basis and within the context of your investment portfolio.

Info Diagram, for instance, differentiates between 5 levels of assets to invest in, based on their risk level: from lowest to highest financial hazard. As shown on the pyramid graph below, the cryptocurrency market is a good example of a high-risk and high-return investment. 

Source: Info Diagram, Risk Return Asset Allocation Trade-off Pyramid

Most investors would diversify their assets to reduce the risks associated with individual investment positions. As often advised, avoiding putting all your eggs in one basket is safe. You can invest in many cryptocurrencies as part of your portfolio diversification. The thing we need to mention and that you most probably have already heard: always choose proven trading platforms. In this way even if you go overboard and invest a big portion of your eggs into the crypto basket, you cannot be victimized by a scam. Among all legitimate trading platforms, one option to consider is Bitcoin Evolution which has received high marks as a top trading platform for beginners.

What Happens at the Portfolio Level? 

The risk-return trade-off also exists at the portfolio level. For instance, your portfolio may be composed of crypto assets with higher risks and higher potential returns. Within the investment portfolio, risk and reward may be increased by concentrating investments in specific projects or taking on single positions that offer a large percentage of holdings

You may also assess the cumulative risk-return trade-off of all your positions, providing insights on whether a portfolio assumes enough risk. Any inputs may help achieve long-term financial targets or identify the best strategies to increase chances of profits while facing greater risks. 

Final Thoughts 

Risks define investments. All business opportunities you will come across have certain risks, so you might as well get to terms with that. By applying the principles of risk-return trade-off, you gain confidence that it’s worth taking risks no matter how threatening they may be. This is particularly important when you join highly volatile markets like cryptocurrency.