Final answer:
The separation principle suggests that an investor should choose an efficient portfolio based on individual risk tolerance. It takes into account the tradeoff between expected return and risk, with investors opting for different investment choices based on personal preferences and the time frame of the investment. Option B is the correct answer.
Step-by-step explanation:
The separation principle, as it pertains to investment choices, indicates that an investor should B. choose an efficient portfolio based on individual risk tolerance or utility. This principle is a fundamental concept in portfolio theory, which suggests that there is a tradeoff between the expected return and the risk involved in investments. Investors often face the decision to invest in low-risk options like bank accounts with low returns, or higher-risk options like stocks that come with the potential for higher returns.
Risky assets, like stocks, must offer a higher average return to compensate for the higher degree of risk. If they did not, it would be less likely for investors to allocate funds to them. The separation principle acknowledges that each investor's portfolio choice will be unique, tailored to their own tolerance for risk and their desired return on investment.
Moreover, examining risk and return in the context of different time frames can influence an investor's decision-making process. Some may prefer a certain level of security with the knowledge of lower returns, while others may choose to accept greater risk for the possibility of earning a high return.