“Risk comes from not knowing what you’re doing.”- Warren Buffett
Investment risk is the probability that an investment will increase or decrease in value.It is the risk that makes investment returns unpredictable. Usually, it is believed that more risk an investment has, more will be the returns.
All investments are subject to risk. When you invest, you choose to take a risk.How many times we have heard or read that all investments have some risks associated with them. An investment without risk is really not an investment at all.
So,what exactly are some of the risks that must be considered when we invest our hard earned money? Here are the types of investment risks: Systematic & Non-systematic.
Systematic: It is associated with the overall market. It’s the risk that is always present whenever the investment is made. For example, risks arising out of inflation, interest rates, political risks etc. This arises primarily from macro-economic and political factors. This risk cannot be diversified away.
Non-systematic: It refers to the strengths or weaknesses associated with the company. It is unique to the company & hence diversifiable. For example, risk arising out of change in management, product obsolescence etc. We can minimize this risk by not investing in just one company.
Ask yourself how you’d feel if your portfolio drops by 20%. A common response would be, “I can’t stand the volatility. It’s keeping me up at night. I want to do something about it!” To rectify the problem, the right action for your portfolio will depend upon which risk have more exposure.
If the drop in your portfolio is due to systematic risk, the right action is to adjust your asset allocation. It means your mix of stocks and bonds is not a match for your true willingness, ability and need to take risk.
If the drop in your portfolio is due to nonsystematic risk, the right action is to adjust your level of diversification. The dip in this case could be due to concentration in a company or sector, and the answer is to broaden exposure to include stocks & bonds of different companies or sectors.
For instance, if you make pasta and it doesn’t taste very good, you want to know if you put in the wrong mix of ingredients or simply didn’t cook it long enough. If the answer is that you forgot to add sauce, no amount of extra cooking is going to fix the taste. The same goes for optimizing your taste for investment risk. So, consider this basic risk investment lesson as you make portfolio decisions.
If You Win, You will be Happy
If You Lose, You will be wise
So keep investing!!!!!!!!
WrittenBy: Charanjeet K. Laungia and Jasleen Rajpal
Certified NISM Mutual Fund Advisor, Interns at Investocafe
To get in touch please visit us at investocafe.com