Investing Basics · definition
Risk (Investing)
In investing, risk is the chance that outcomes differ from what you expected, especially the chance of losing money. It comes in distinct flavours that behave differently.
Risk, in investing, is the possibility that results turn out different from expectations, and in everyday use, the possibility of losing money. The word hides several distinct phenomena that behave differently and are managed differently, which is why finance keeps a taxonomy of them.
Key takeaways
- Risk and expected return are linked: compensation for bearing risk is where investment return comes from.
- Different risk types (market, credit, inflation, liquidity, concentration) call for different responses.
- Volatility is the standard statistical proxy for risk, and an imperfect one.
- Risk that can be diversified away (company-specific) earns no extra expected return; market-wide risk cannot be diversified away.
The main types
| Type | What can go wrong | Described under |
|---|---|---|
| Market risk | Broad prices fall together | bear market |
| Credit risk | A borrower fails to pay | bond |
| Inflation risk | Money buys less than planned | inflation |
| Interest-rate risk | Rate moves reprice assets | Treasury securities |
| Liquidity risk | Selling is slow or costly | liquidity |
| Concentration risk | One position dominates | portfolio |
| Currency risk | Exchange rates move against you | xenocurrency |
Systematic versus unsystematic
Finance theory splits risk in two. Unsystematic (company-specific) risk, a fraud, a failed product, disappears almost entirely in a diversified portfolio, which is the core message of diversification. Systematic (market-wide) risk remains no matter how many holdings you own; bearing it is what equity investors are, on average and over long periods, compensated for. The capital asset pricing model built an entire pricing framework on that distinction.
Measuring it, imperfectly
The standard statistical measure is volatility (the standard deviation of returns), with refinements such as beta (sensitivity to the market), maximum drawdown (worst peak-to-trough fall) and value-at-risk. Each captures part of the picture. None captures the risk that matters most to a household: the chance of not having the money when it is actually needed, which depends on time horizon and circumstances as much as on any statistic. Matching risk to a person is suitability, the regulated territory of licensed advisers.
Frequently asked questions
Is cash risk-free?
Free of price swings, not of risk: inflation erodes its purchasing power, which over decades is a large, quiet loss. "Risk-free" in finance jargon refers narrowly to default risk on short government paper.
Does higher risk guarantee higher return?
No. Higher expected return is compensation for bearing risk, but the realised outcome can be poor; that is what makes it risk rather than a fee schedule.
Sources
This entry is for education only. Investing Value describes how financial concepts work; it does not provide investment, tax or legal advice, and nothing here is a recommendation to buy or sell any asset.