Wednesday, 29 April 2009 08:25
Barron’s Finance and Investment Handbook has a very simple definition of risk: The measurable possibility of losing or not gaining value. To go a little farther, there are several types of risks that can be in your portfolio. Recognition and understanding are key to managing the risk that might be in your portfolio. Following is a brief overview categorizing risk into to four broad areas.
Market Risk: this is the risk that the value of your security will move as the market moves. For example, if the stock market is in a decline your mutual funds might lose value too.
Interest Rate Risk: This is most often linked to fixed-income investments and relates to the fact that the price of your investment instrument will fluctuate with changing interest rates.
Inflation Risk: This is the risk that your portfolio will lose value over time because the rate of inflation is greater than your rate of return over a long period of time.
Credit Risk: This risk mainly is associated with bonds and bond funds. It is based upon the issuer’s ability to repay its debt as promised when the bond matures.
After understanding the risks in your portfolio you can then better diversify not just for better returns but also to better manage the impact of risk. Before choosing a risk diversification strategy it would be important to evaluate and adjust your savings goals.