The investment portfolio risk is the possibility that one has of not achieving its objectives. There are a number of factors that contribute to this and as long as you are willing to minimize them, you will never be able to eliminate them completely.
Systematic risk is a contributing factor to portfolio risk. Besides that, you can never delete it. The first includes the risk associated with interest rates, recession, war and political instability. All these factors can have significant repercussions for companies and the prices of their shares. By their nature, these are somehow unpredictable. While you are able to determine the long-term direction of interest rates, you will not be able to predict the amount that will grow or fall. And in most cases, the stock market will “put a price” on the anticipated change, long before the investor considers it.
This is the risk you can control, or at least minimize. Also known as “specific risk,” it relates to the one associated with owning the shares of a specific company in your portfolio. As you increase the number of different companies, you essentially spread the risk through your portfolio, and therefore, reduce the overall impact of a low-yield action.
Diversification, or “not putting all your eggs in a basket”, is the first method to reduce the “specific risk” within your portfolio. Not only do you need to be the owner of different companies, but you also need to be the owner of companies from different sectors. If you invest all your money in bank shares, you can reduce the impact a company will have on your money, but you will not have eliminated the effect that the sector may have on your investments.
More than just actions
Another way to improve your portfolio diversification is to invest in other types of assets. “Balanced mutual funds” invest a portion of the money through short-term stocks, bonds and cash investments such as treasury securities. By adding these, which may have a higher level of security and provide income, you also reduce your portfolio risk.
Understand your risk tolerance
Having a clear understanding of your risk tolerance will be a significant factor in achieving your investment objectives. It is very easy to get on the wave of a stock market that grows day by day without an end in sight. It is a completely different story when a “hit” or a prolonged period of daily losses begin to happen. Understanding your comfort level during those moments will help eliminate the possibility of making a hasty decision at the wrong time.