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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 that are held within a financial portfolio. Unlike other types of risk that may affect one or more of the holdings within a portfolio, this form of risk relates only to a particular investment, and does not impact what is happening with the other holdings. Assessing diversifiable risk can be very helpful when attempting to diversify the portfolio in a fashion so that whatever is happening in the marketplace leads to limited losses overall.
One of the easiest ways to understand the concept of a diversifiable risk is to consider the value of stock issued by a specific company. If the business begins to experience a decrease in sales, this will likely have a negative impact on the unit price of the shares of stock. The fact that the stock of this one company declines somewhat does not mean that any of the other holdings within the portfolio will also undergo a similar decline. Since the reason for the change in value has to do with a specific situation related to that one 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.
In order to maintain a relatively low level of diversifiable risk, investors must choose investments with care. This means that while stocks may compose roughly half of the holdings within a portfolio, choosing to acquire shares issued by companies operating in several different industries will result in reducing the chance of depressed sales in one particular market sector from undermining the investor’s overall worth. By making sure that reversals with one stock is unlikely to also be relevant to other stocks currently held, the investor helps to further reduce the potential for a loss, while still maintaining a good chance of experiencing steady returns.
While using strategies to help minimize diversifiable risk can help provide additional stability to a portfolio, there are other risk factors that may still affect a wider range of the assets held within a portfolio. A good example is a shift in the interest rates that apply to any holdings structured to provide a return based on a floating or flexible rate of interest. Changes of this type may result in an increase or decrease of a number of holdings, even if there is a great deal of diversity among the assets that are currently held in the investor’s portfolio.
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