Asset Allocation and Investment Risk

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Asset Allocation and Investment Risk

Asset allocation is a technique used to balance the risk of a portfolio in such a way as to avoid taking too much risk for a given level of expected return. Investment risk is usually measured by how much the investment price varies. The risk is also compared to the variance of all similar investments.

Things To Know

  • Calculated risk means studying as many factors as possible and choosing the most promising course of action.
  • Investment risk can also be measured by an investment’s volatility, such as beta.

Investment risk

We tend to think of investment risk as the chance of loss due to the uncertainty of future events. Many factors (or risks) can affect the values of your investments. For example, there are risks in political systems that can reduce the value of an investment. A company you invest in may undergo unforeseen changes in management. Investor emotions may be unpredictable. Uncertainties in exchanges, rates of currencies, and in interest rates also affect investments.

Calculated risk

Usually an investor can deal with risk in two possible ways: one is to simply gamble with it, and the other is to study as many factors as possible and choose the most promising course of action. This latter option is called calculated risk.

Beta

Investment risk can also be measured by the volatility of an investment. The volatility is the amount that the price fluctuates above and below the previous price. Economists have developed a mathematical tool to "measure" this fluctuation. The Greek letter beta (β) represents this measurement.

A beta of one means that an investment is as volatile as the rest of the market. The higher the beta, the higher the risk; the lower the beta, the lower the risk. Beta is a useful tool in selecting investments for your portfolio and to measure the risk in your portfolio.