What are the trade-offs that investors consider when making investments? Explain what each of
these aspects mean. Give one example of these trade-offs. (4 points)
1. Risk vs. Return: This trade-off involves balancing the level of risk a potential investment carries with the potential return or reward it offers. Higher-risk investments generally have the potential for higher returns, but they also come with a higher chance of loss. An example of this trade-off would be investing in a high-risk tech startup with the potential for significant returns, but also a high possibility of failure.
2. Liquidity vs. Security: This trade-off involves choosing between investments that offer high liquidity (the ability to quickly convert an asset into cash) and those that offer higher security or stability. Investments with high liquidity, such as stocks or bonds, may provide easier access to funds but could be more volatile and subject to market fluctuations. On the other hand, investments like real estate or long-term bonds offer more stability but may be less liquid. An example of this trade-off would be choosing between investing in a savings account with easy access to funds versus purchasing a property that offers more security but limited liquidity.
3. Time horizon vs. Return: This trade-off involves considering the length of time an investor is willing to hold an investment and how it may impact potential returns. Shorter-term investments may offer quicker returns but could be more volatile, while longer-term investments have the potential for higher returns but require patience and a longer commitment. An example of this trade-off would be deciding between investing in a high-yield savings account for short-term gains versus committing to a long-term investment in a retirement fund for more substantial returns over time.
4. Diversification vs. Concentration: This trade-off involves balancing a diversified portfolio with a concentrated portfolio. Diversification spreads risk across different assets, reducing potential losses if one investment underperforms. On the other hand, concentration focuses investments in a few select assets, potentially leading to higher returns but also higher risk. An example of this trade-off would be choosing to spread investments across various industries and asset classes for diversification or concentrating heavily on one particular sector for potentially higher returns.