What is Portfolio Risk?

Jim B.

Portfolio risk refers to the combined risk attached to all of the securities within the investment portfolio of an individual. This risk is generally unavoidable because there is a modicum of risk involved in any type of investment, even if it is extremely small. Investors often try to minimize portfolio risk through diversification, which involves purchasing many securities with different characteristics in terms of potential risk and reward. There are some risks which cannot be solved through diversification, and these risks, known as market risks, can only be lessened by hedging with contrasting investments.

An effective way to minimize risk in portfolio management is through diversification.
An effective way to minimize risk in portfolio management is through diversification.

Many people who haven't actually begun to invest their capital only foresee the positives and potential gains that come with putting one's money into a specific security. In reality though, investment of any kind carries the risk that the capital at stake will either be lessened or lost completely. When all of the investments in a portfolio are added together, their combined risk is known as the portfolio risk.

Portfolio risk refers to the combined risk attached to all of the securities within the investment portfolio of an individual.
Portfolio risk refers to the combined risk attached to all of the securities within the investment portfolio of an individual.

Investors use many different means to attempt to lessen the portfolio risk that they must incur. Diversification of a portfolio is one such way to achieve this, as it entails building a portfolio full of disparate securities and different types of investments. By doing this, the risk that one or even a few securities will underperform is mitigated by the fact that there are plenty of others in the portfolio to balance them out. In addition, choosing different types of securities, like some stocks and some bonds, can protect the investor from one security type going through a slump.

Some risks are resistant to diversification tactics and they represent a different challenge for an investor managing portfolio risk. These risks are known as market risks, or systematic risks, and they can sweep through an entire market or segment of the market. For example, an economy in recession will likely cause a broad range of securities to suffer, thus harming even a diversified portfolio. Investors must try to make investments known as hedges, which essentially bet against the performance of the assets they already possess, in times like these.

It should be noted that a savvy investor is willing to accept a certain amount of portfolio risk as a trade-off for the potential for high investment rewards. After all, the securities that have the lowest degree of risk, like government-issued bonds, also provide very little return on investment. Investors seeking growth must be able to take on a little risk to get the kind of returns they're seeking for their portfolio.

Portfolio risk is generally unavoidable.
Portfolio risk is generally unavoidable.

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Discussion Comments


@stl156 - Unfortunately, you are in the same situation as a lot of other people. One of the things that very few people learn in high school or college is how to manage money once they actually start making it. It is good that your job offers a 401(k) plan. Depending on how much you make and whether you have the ability to set aside more money, you may also want to start up an IRA.

As far as what stocks to pick and how to balance your portfolio, that is always going to be a personal preference. Some people are very comfortable picking high risk stocks and hoping for the best. Others would rather keep more guaranteed money. The thing to remember is that you'll always be making and losing money. The key is just to put yourself in a position to succeed in the long term.

I would highly suggest checking out Fool.com. It is highly regarded financial website that has a lot of great information for beginners. If you still aren't comfortable with managing your money, the next step would be to talk to a financial planner.

I just recently started my first "real" job where I actually get the chance to invest in retirement funds. The problem is that I have never really had any training in portfolio risk management.

Whenever we were at our orientation, the individuals there showed us some pre-set options for our 401(k) plans based on the amount of risk we were willing to take. For the time being, I have mine on the medium risk plan. Is that a good idea, or should I go with more or less risk? To be honest, I don't even know that I completely understand what everyone means when they talk about portfolio risk and returns.

Does anyone have any good advice about what I should do? I am very interested in learning about how to grow my money, but I don't really know how to start.

@cardsfan27 - It is nearly impossible to say what the exact formula would be. If it were that simple, everyone would be rich. I will say, though, that having 50% of your investments in stocks in a competition like this is quite low. In real life, the general baseline is to take 100 minus your age, and that is the percentage of your investments that should be in stocks. Although they aren't as safe, you have the potential to get the most return from stocks.

Obviously, picking the right stocks is the key. Like I said, there's no golden strategy to do that. It just takes research and a bit of luck. If you haven't discovered it yet, I would highly suggest looking at online sites that include free information about stocks, like their health ratings and predicted rate of success.

I am a senior in high school, and in my finance class, we have been talking about how the stock market and investments work. One of the things we do throughout the school year is set up accounts on a website that lets you simulate having money invested in real-life stocks and other things. There is no real money involved, though.

So far, I have been doing pretty good, but I would like to finish at the top of the class. Whoever finishes the school year with the most money wins some sort of secret prize. Besides having bragging rights, I think learning about investments will be a big benefit to me later on in life, too.

Basically, what I am wondering about most is what percentage of my money should be in what types of investments. Currently, I have about half in stocks, 30% in mutual funds, and the rest split between bonds and gold. Does anyone have any advice for my portfolio management?

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