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)
in simple terms not too long
1. Risk and Return: Investors consider the level of risk associated with an investment and the potential return it could provide. Generally, higher risk investments have the potential for higher returns, but also a higher chance of loss. An example of this trade-off could be investing in a high-growth tech startup versus a stable blue-chip stock.
2. Liquidity and Longevity: Investors must weigh the liquidity of an investment, or how easily it can be converted into cash, against the longevity of the investment. Investments that are more liquid typically offer lower returns compared to long-term investments that may tie up capital for a longer period. For example, investing in a high-yield savings account offers easy access to cash but lower returns compared to locking money into a long-term bond.
3. Diversification and Concentration: Investors must balance the benefits of diversifying their portfolio across different asset classes and markets with the potential benefits of concentrating their investments in a few select opportunities. Diversification can help mitigate risk, but may also limit potential returns compared to concentrating investments. An example could be investing in a mix of stocks, bonds, and real estate versus putting all money into a single stock.
4. Time and Effort: Investors must consider the amount of time and effort required to manage their investments. Actively managing a portfolio may yield higher returns but also require more time and expertise, whereas passive investing may be more hands-off but potentially limit returns. An example of this trade-off could be actively trading stocks versus investing in a low-cost index fund for long-term growth.