How Do Different Types Of Risk Influence A Portfolio?Essentially, in investment types of risk can be described as the uncertainty of future returns. Since share and stock prices move up and down, potentially changing all day every day, this uncertainty can be very real. The movement of prices, known as volatility, is caused by one or both of two factors. These are: Market Risk cannot be avoided and has an effect on an entire investment market. It is also known as Systematic Risk. In recent years, this type of risk seems to hit most if not all major stock exchange indices at the same time. In this connected world, very little appears to be safe. Some things are likely to cause this market risk. For example, there may be significant changes in a national economy. This may and often does take the form of changes to interest rates, inflation or unemployment predictions, GDP growth and so on. Other factors might include changes to taxation rules made by a government. Obviously, the private investor can only avoid such perils by remaining out of each and every market! It could be said that broadly, all companies have a similar exposure to systematic risk. > Investment Specific Risk This is specific to a company or industry. It is also known as Unsystematic Risk. The factors which cause this are generally not connected to political or national economic factors. Examples of factors which might include Investment specific risk are: - New competitors entering a market, - Technological improvements which render existing products or business processes obsolete, or - Changes to the credit rating (and therefore borrowing costs) of a company These are types of risk that can be reduced or limited by holding a diversified portfolio. This is possible because different companies will be impacted by the same changes in different ways. An investor may hold positions in companies that will deliberately move in opposing directions at news of the same events to lower the risk and price volatility in a portfolio. However, should all assets move in broadly the same direction at the same time, this offsetting would not work. Other related pages include:
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