Portfolio risk refers to the combined risk attached to all of the securities within the investment portfolio of an individual. This risk is generally unavoidable because there is a modicum of risk involved in any type of investment, even if it is extremely small. Investors often try to minimize portfolio risk through diversification, which involves purchasing many securities with different characteristics in terms of potential risk and reward. There are some risks which cannot be solved through diversification, and these risks, known as market risks, can only be lessened by hedging with contrasting investments.
Many people who haven't actually begun to invest their capital only foresee the positives and potential gains that come with putting one's money into a specific security. In reality though, investment of any kind carries the risk that the capital at stake will either be lessened or lost completely. When all of the investments in a portfolio are added together, their combined risk is known as the portfolio risk.
Investors use many different means to attempt to lessen the portfolio risk that they must incur. Diversification of a portfolio is one such way to achieve this, as it entails building a portfolio full of disparate securities and different types of investments. By doing this, the risk that one or even a few securities will underperform is mitigated by the fact that there are plenty of others in the portfolio to balance them out. In addition, choosing different types of securities, like some stocks and some bonds, can protect the investor from one security type going through a slump.
Some risks are resistant to diversification tactics and they represent a different challenge for an investor managing portfolio risk. These risks are known as market risks, or systematic risks, and they can sweep through an entire market or segment of the market. For example, an economy in recession will likely cause a broad range of securities to suffer, thus harming even a diversified portfolio. Investors must try to make investments known as hedges, which essentially bet against the performance of the assets they already possess, in times like these.
It should be noted that a savvy investor is willing to accept a certain amount of portfolio risk as a trade-off for the potential for high investment rewards. After all, the securities that have the lowest degree of risk, like government-issued bonds, also provide very little return on investment. Investors seeking growth must be able to take on a little risk to get the kind of returns they're seeking for their portfolio.
