Final answer:
Investments are arranged based on their risk-return tradeoff, with stocks generally presenting the highest risk and potential return, followed by bonds, and then bank accounts with the lowest risk and return. Personal investment strategy dictates choices, influenced by individual risk tolerance and investment time horizons.
Step-by-step explanation:
The subject of this question is the tradeoff between expected return and risk in household investment choices. This tradeoff dictates the arrangement of investments from highest to lowest potential for risk and return. Typically, stocks have the highest risk but also the highest potential return, bonds are intermediate with higher risk and returns compared to bank accounts, and bank accounts are the safest with the lowest risk and returns. The general principle is that higher risk is associated with higher potential returns to compensate investors for taking on more uncertainty.
This alignment is predicated on the fact that each asset class has a different level of volatility and growth potential. Stocks, for instance, can offer substantial gains during a market upswing but can also lead to significant losses in a downturn. Bonds, being loans to governments or corporations, provide regular interest payments and return of principal, but can be affected by interest rate changes and credit risk. Finally, bank accounts offer very low returns but the principal is often guaranteed up to a certain amount by institutions like the FDIC in the USA.
Choices about risk and return are ultimately based on personal preferences and time frames for investment. Short-term financial goals may favor lower-risk investments, while long-term goals might allow for taking on more risk with the aim of achieving higher returns.