Risk/Return Tradeoff

Higher risk bless all with greater rewards. Returns are the gains or losses from security in a particular period and are usually quoted as a percentage. In the investing world, the dictionary definition of risk is the chance that an investment's actual return will be different than expected. Risk means you have the possibility of losing some, or even all, of your original investment. Systematic Risk: Also known as "market risk" or "un-diversifiable risk", systematic risk is the uncertainty inherent to the entire market or entire market segment. Also referred to as volatility, systematic risk is the day-to-day fluctuations in a stock's price. Volatility is a measure of risk because it refers to the behavior, or "temperament," of your investment rather than the reason for this behavior. Because market movement is the reason why people can make money from stocks, volatility is essential for returns, and the more unstable the investment the more chance there is that it will experience a dramatic change in either direction.

Unsystematic Risk: Also known as "specific risk," "diversifiable risk" or "residual risk," this type of uncertainty comes with the company or industry you invest in and can be reduced through diversification. Higher risk is associated with a greater probability of higher return and lower risk with a greater probability of smaller return. This tradeoff which an investor faces between risk and return while considering investment decisions is called the risk-return trade-off.

Mythical Investors Risk – Behavioral and Perceptual 

Risk-neutral is a mindset where an investor is indifferent to risk when making an investment decision. The risk-neutral investor places himself in the middle of the risk spectrum, represented by risk-seeking investors at one end and risk-averse investors at the other. 

Regret Theory

Fear of regret or simply regret theory deals with the emotional reaction people experience after realizing they've made an error in judgment. Faced with the prospect of selling stock, investors become emotionally affected by the price at which they purchased the stock.

Mental Accounting

Humans have a tendency to place particular events into mental compartments and the difference between these compartments sometimes impacts our behavior more than the events themselves.

Prospect/Loss-Aversion Theory

It doesn't take a neurosurgeon to know that people prefer a sure investment return to an uncertain one – we want to get paid for taking on any extra risk. That's pretty reasonable.

Here's the strange part. Prospect theory suggests people express a different degree of emotion towards gains than towards losses. Individuals are more stressed by prospective losses than they are happy from equal gains.

References:

BPP, Kaplan, and Investopedia.

-Francisco Faraco (Morgan Stanley)