What is "systematic risk"?

Systematic risk is the risk associated with broad events that affect the entire market or market sector that cannot be mitigated through diversification.

What is "unsystematic risk"?

Unsystematic risk is the risk associated with a particular industry or market sector that can be mitigated through having a diversified portfolio of stocks.

What is a "risk/return trade-off?"

A risk/return trade-off is the principle that the higher the level of uncertainty as to a potential return, the higher the reward. An investment with a relatively predictable low level of uncertainty will have a lower return. This is why individual investors must clearly understand their personal tolerance for risk in order to make the right choices when investing in individual stocks.

How many individual stocks must I own to have enough diversification against unsystematic risk?

Although many experts disagree with assigning an exact number, a diversified portfolio of individual stocks should fall within a range of between 12 and 25 stocks. The answer may be quite complex, as it based upon your tolerance for risk. Investors who are quite risk-averse will seek more diversification, and hold more individual positions. In contrast, an investor with a high tolerance for risk may hold fewer individual positions.

How do professional investors feel about risk?

Many professional investors believe the mitigation of risk is probably as important as analyzing and making specific investments. Over time, investors are rewarded with higher returns in exchange for putting their money at higher risk. But many professional managers believe you can mitigate risk by buying and holding various assets over time, and selecting assets with minimal correlation, so that if any one asset decreases in value, others may increase in value or be unperturbed by the cause of the decline. By diversifying your portfolio with uncorrected assets, you may be able to experience increases in the values of your portfolio without having to deal with sharp declines.

 
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