Question

Explain why in the long run the rate of return on investments reflect the riskiness of those investments.

Answer 1

The risk-return relationship describes that the probable return rises with an increase in risk. By using this principle, individuals who has low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns. According to the risk-return relationship, invested money can render higher profits only if the investor will accept a higher possibility of losses.

The risk-return relationship is the trading principle that links high risk with high reward. The appropriate risk-return relationship depends on a variety of factors including the capacity of risk tolerance by an investor’s, the investor’s years to retirement and the potential to replace lost funds. Time also plays an important role in determining a portfolio with the appropriate levels of risk and reward. If an investor has the ability to invest in equities over the long term, then it will provide the investor with the potential to recover from the risks of bear markets and participate in bull markets, while if an investor can only invest in a short time frame, the same equities have a higher risk proposition.

As the future is uncertain so the risk is also high. So, rate of return on investments also reflect the riskiness of those investments.