Diversifiable risk is limited volatility or risk relevant to a specific investment, not affecting other holdings in a portfolio. Careful investment choices can reduce diversifiable risk, but other risk factors can still affect a broader range of assets.
Diversifiable risk is the level of volatility or risk that is relevant to a given security, but is somewhat limited due to the range of investments held within a financial portfolio. Unlike other types of risk that can affect one or more of the holdings within a portfolio, this form of risk relates only to a particular investment and does not affect what happens to other holdings. Assessing diversifiable risk can be very helpful when trying to diversify your portfolio so that whatever is happening in the market leads to limited overall losses.
One of the easiest ways to understand the concept of diversifiable risk is to consider the value of the shares issued by a specific company. If the business begins to experience a decline in sales, this will likely have a negative impact on the unit share price. Just because this company’s stock declines somewhat does not mean that any of the other holdings in the portfolio will also suffer a similar decline. Since the reason for the change in value has to do with a specific situation related to that holding, the overall impact on the portfolio is minimal and may even be offset by the performance of the other assets held by that investor.
To maintain a relatively low level of diversifiable risk, investors must choose investments carefully. This means that while stocks may make up about half of the holdings within a portfolio, choosing to purchase shares issued by companies that operate in several different industries will reduce the possibility of depressed sales in a particular market sector. undermine overall investor value. By ensuring that reversals with one stock are unlikely to also be relevant to other stocks currently held, the investor helps further reduce the potential for a loss, while maintaining a good chance of experiencing consistent returns.
While using strategies to help minimize diversifiable risk can help provide additional stability to a portfolio, there are other risk factors that can still affect a broader range of assets held within a portfolio. A good example is a change in interest rates that apply to any participation structured to provide a return based on a variable or flexible interest rate. Changes of this type can result in a number of holdings going up or down, even if there is great diversity among the assets currently in the investor’s portfolio.
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