What is portfolio risk?

Portfolio risk refers to the combined risk associated with all securities in an individual's investment portfolio. This risk is generally unavoidable because there is a minimal amount of risk involved in any type of investment, even an extremely small one. Investors often try to minimize portfolio risk through diversification, which involves buying many securities with different characteristics in terms of potential risk and reward. There are some risks that cannot be resolved by diversification, and these risks, known as market risks, can only be mitigated by hedging with contrasting investments.

Many people who have not yet started investing their capital only anticipate the positive and potential benefits that come with putting money into a specific security. In reality, however, investing of any kind carries the risk that the capital at stake will be diminished or lost altogether. When all investments in a portfolio are added together, their combined risk is known as portfolio risk.

Investors use many different means to try to reduce the portfolio risk they are expected to incur. Diversifying a portfolio is one way to achieve this, as it involves building a portfolio filled with disparate securities and different types of investments. In doing so, the risk of one or even a few underperforming stocks is mitigated by the fact that there are many others in the portfolio to balance them out. Also, choosing different types of bonds, such as some stocks and some bonds, can protect an investor from a type of bond that is going down.

Some risks are resistant to diversification tactics and present a different challenge for an investor managing portfolio risk. These risks are known as market risks, or systematic risks, and can span an entire market or market segment. For example, a down economy is likely to hurt a wide range of stocks, hurting even a diversified portfolio. Investors should try to make investments known as hedges, which essentially bet against the performance of the assets they already own at times like these.

It should be noted that a smart investor is willing to accept a certain amount of portfolio risk as compensation for the potential for high investment rewards. After all, bonds that carry the least degree of risk, such as government-issued bonds, also offer very little return on investment. Investors looking for growth need to be able to take a little risk to get the kind of return they want from their portfolio.