Final answer:
A risk-averse investor seeks a higher expected return to justify taking on additional risk, as they have a preference for certainty and require adequate compensation for the uncertainty introduced by potentially higher-risk investments such as stocks.
Step-by-step explanation:
A risk-averse investor requires a higher expected return to compensate them for more risk. This concept is grounded in the tradeoff between expected return and the degree of risk assumed by the investor. Generally, as the risk of an investment increases, so does the potential for higher returns. Investments can come in various forms, with different risk profiles such as bank accounts, bonds, and stocks. For instance, bank accounts usually offer very low risk accompanied by low returns, whereas stocks carry a higher risk but also the possibility of still higher returns.
It is the nature of risk-averse investors to prefer certainty to uncertainty, which means they are only willing to take on additional risk if they believe they will be adequately compensated with a greater expected rate of return. This relationship underlines the core reason why offerings such as stocks must have a potential for higher returns to attract investors: without the promise of a greater reward, the inherent risk would deter the investor seeking to safeguard their capital.