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Risk and Diversification: What Is Risk?
Whether it is investing, driving, or just walking down the street, everyone exposes themselves to risk. Your personality and lifestyle play a big role in how much risk you are comfortably able to take on. If you invest in stocks and have trouble sleeping at night, you are probably taking on too much risk. (For more insight, see A Guide To Portfolio Construction.)
Risk is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment.
Those of us who work hard for every penny we earn have a harder time parting with money. Therefore, people with less disposable income tend to be, by necessity, more risk averse. On the other end of the spectrum, day traders feel if they aren't making dozens of trades a day there is a problem. These people are risk lovers.
When investing in stocks, bonds, or any investment instrument, there is a lot more risk than you'd think. In the next section, we'll take a look at the different kind of risk that often threaten investors' returns.
Next: Risk and Diversification: Different Types of Risk
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