Thursday, December 23, 2010

Risk

Risk is an important concept in investment. At the basic level risk refers to the probability or possibility of losing money. For example an equity investor is exposed to losing their entire investment, whereas an investor in government debt generally has a very low chance of losing their entire investment because the government can print money to repay the debt. At a more scientific level risk refers to the volatility of an investment or the variability of returns. For example an asset may have an average return of 5% but within that average the returns might have ranged between -20% and 25%, which is clearly a different experience than a 5% return. It is important to understand the risk profile of an investment, particularly compared to return. Generally a rational investor will seek to maximise return while minimising risk. The main metric used for measuring risk is volatility of returns or the standard deviation of returns - this is a statistical calculation which most funds or advisers will provide in their reports or provide on request.

Synonyms: Volatility, Return variance, Variance, Uncertainty, Instability, Standard deviation

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