Portfolio risk is the combined risk of all securities in an investment portfolio. Diversification can help reduce risk, but market risks cannot be resolved through diversification and require hedging with contrasting investments. Investors must accept some risk for potential high rewards.
Portfolio risk refers to the combined risk associated with all the securities within an individual’s investment portfolio. This risk is generally unavoidable because there is minimal risk involved in any type of investment, even if it is extremely small. Investors often try to minimize portfolio risk through diversification, which involves buying many securities with different characteristics in terms of potential risk and reward. There are some risks that cannot be resolved by diversification, and these risks, known as market risks, can only be reduced by hedging with contrasting investments.
Many people who haven’t really started investing their capital only envision the positive and potential benefits that come with putting money in a specific security. In reality, however, investing of any kind carries the risk that the capital at stake will be diminished or lost entirely. When all the investments in a portfolio are added together, their combined risk is known as portfolio risk.
Investors use many different means to try to decrease the portfolio risk they must incur. Diversifying a portfolio is one way to achieve this, as it involves building a portfolio filled with disparate stocks and different types of investments. By doing this, the risk of one or even a few securities underperforming is mitigated by the fact that there are many others in the portfolio to balance them out. Also, choosing different types of securities, such as some stocks and some bonds, can protect the investor from a type of security going through a slump.
Some risks are resistant to diversification tactics and present a different challenge to an investor managing portfolio risk. These risks are known as market risks, or systematic risks, and can span an entire market or market segment. For example, a down economy is likely to hurt a wide range of stocks, hurting even a diversified portfolio. Investors should try to make investments known as hedges, which essentially bet against the performance of the assets they already own, at times like these.
It should be noted that a smart investor is willing to accept a certain amount of portfolio risk as compensation for the potential for high investment rewards. After all, securities that carry the lowest degree of risk, such as government-issued bonds, also provide very little return on investment. Investors looking for growth need to be able to take a little risk to get the kind of return they seek from their portfolio.
Smart Asset.
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