Investment risk can be defined as the chance of financial losses associated with a particular investment decision. It measures the uncertainty of the expected return and plays an important role in assessing an investment.
Risk that affects the asset value can be classified into two categories: systematic risk and unsystematic risk. Total risk is the sum of systematic risk and unsystematic risk.
Systematic risk, also known as market risk, is affected by the market on a large scale instead of a single security. Systematic risk is hard to eliminate through diversifying your investment portfolio. Common sources of systematic risk include changes in policy, natural disasters, war, and economic cycles.
Unlike systematic risk, unsystematic risk is connected to specific securities or industries and can be mitigated through portfolio diversification. Even with a well-diversified portfolio and the utilization of hedging, not all unsystematic risk can be avoided.
Standard deviation is the most common metric used when measuring risk. The volatility of asset prices can be observed by calculating the current return and comparing it with historical averages. It indicates the deviation from expected returns.
The Sharpe ratio compares the risk and adjusted return of an investment. When evaluating different investments, one can tell by calculating the Sharpe ratio whether the return is worth the risk and which option generates a higher return for a given risk level.
Beta is used to measure the relative volatility between a security and the whole market. When beta is greater than one, the security is more volatile than the market, and vice versa. Note that when comparing two or more securities, a higher beta indicates a greater volatility and, thus, greater risk.
R-squared measures how well a security's movement can be explained by the changes in the benchmark index. R-squared is most useful when determining which factor causes the most change in the security price.
Risk-return tradeoff is described as the relationship between risk and return. Typically, taking a higher risk of losing money will generate a greater likelihood of higher returns on an investment. Risk-return tradeoff is an essential component of the investment decision-making process.
Risk profile is the evaluation of an investor's willingness and ability to take risks and can be shaped by factors such as age, investment goals, and personal preferences. It is crucial when determining the proper asset allocation for an investment portfolio.
The maximum level of risk one is willing to accept when investing.
The amount of risk one is able to take in order to achieve investment goals.
The amount of risk one is willing to accept to achieve certain objectives.
The investor tends to avoid risk even if it means giving up a potentially higher return.
The investors' investment decisions are not influenced by the risk level.
The investor is willing to bear larger risks when tempted by higher returns.