By definition risk is the outcome which could be different what you expected. Think about a business where you can’t find customers, or a new home where your basement gets flooded every time there is heavy rain. When it comes to investment you can lose portion or all of your money. When we talk about risk we usually talk about negative outcome.
You have to learn how much risk you can take. It depends on your personality, your experience, your age, your responsibilities. Don’t take more risk than what you can handle. Not only you can lose all your money but it can ruin your health and your relationships. Some people hate to take any risk some people love to take risks (which could be dangerous too)
In the world of investing there are different types of risks. The main risks are classified as:
· Systematic Risk is when a large number of assets are affected. A major political event can trigger one. It’s harder to protect yourself from this class of risk.
· Unsystematic Risk when only a specific stock or a small number of stocks are affected. An earnings report, retail sales report, oil inventories can trigger one.
Other types or risks are Credit Risk, Country Risk, Foreign-Exchange Risk, Interest Rate Risk, Political Risk and Market Risk.
Risk is the reason why prices move, without risk it would be hard to make money with any investment.
We measure risk with volatility. The higher the volatility the bigger market moves are expected. You take a bigger risk when you buy assets with higher volatility. Volatility can be measured with standard deviation.
The higher the risk the higher the return could be but the losses could be bigger too. For example buying options is riskier than buying stocks or buying leveraged ETFs is riskier than buying unleveraged ETFs.
You can protect your portfolio from various risks with diversification but you can never completely eliminate it. Diversification means buying at least 10-12 different securities from different asset classes, such as stocks, options, bonds, gold, real estate, currency and keep some cash too.