A fundamental concept of investing is the relationship between risk and return.

The “risk-free” rate of return is normally quoted as the return offered on Government Treasury Bills (T-Bills for short). While there is no risk of losing your principal, you will only earn a very small rate of return. Nonetheless, the small return is guaranteed. (Note that as of April 21^st, 2008 the 1 month Canadian T-Bill rate was an annualized 2.74%.)

If an investor is willing to take on risk it would only be rational to expect to be compensated for this risk through a higher potential return on their investment. The greater the potential return, the greater the risk. This is a fundamental relationship. However, it should also be noted that the relationship is not linear in nature. Rather, for every extra unit of potential return you desire you should expect a disproportionately greater amount of extra risk - risk grows exponentially with potential return. This relationship is presented in the figure below.

(You can click on the figure for a larger view)

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