The probability of returns being different (either more or less) from the expected return of any particular investment.
Every financial venture involves a degree of uncertainty, as all investments carry a certain amount of risk. Whether you are a conservative saver or an aggressive trader, the potential for market fluctuations means that your final results may differ from your initial projections. The specific nature of the risk in a portfolio is never static; rather, it shifts and evolves based on the specific assets you hold—such as stocks, bonds, or digital currencies—and the asset allocation or proportion in which you hold them.
To effectively manage a portfolio, investors must distinguish between the two primary categories of volatility. Investment risks are generally classified as either Systematic Risk or Unsystematic Risk. Understanding the interplay between these two forces is essential for aligning your financial strategy with your personal risk tolerance and long-term goals.
Understanding Systematic vs. Unsystematic Risk
Systematic Risk: Risk typically affecting the market as a whole, or a large number of assets. Typically systematic risk is unpredictable and hence difficult to avoid. Examples include a new law, regulation, change in taxation etc., with such announcement affecting the assets price.
Unsystematic Risk (Diversifiable Risk): A specific risk uniquely affecting a company or industry. An example of this is car assembly lines being halted due to a shortage in chipsets for the electronics of the new vehicles. Diversification can reduce unsystematic risk in an investment portfolio.
As a general rule, the higher the risk of an investment, the higher the potential return and also the higher the potential variability of the return. If we take for example the cryptocurrency Bitcoin. There are potentially high returns to be made by holding Bitcoin, but there is also high volatility. It’s not uncommon for Bitcoin to fluctuate 20% or more in a single day. And volatility goes two ways. Although there is the potential for a high return, there is also the potential for a higher loss.
How to Manage Risk in Your Investment Strategy
So when considering investment risk, consider the proportion of that investment in your portfolio, and if you are willing to accept the systematic/unsystematic risk the addition of that asset brings.
