What is 'Risk of Ruin'

Risk of ruin is the probability of an individual losing substantial trading or gambling money (known as capital base) to the point at which continuing on is no longer considered an option to recover losses.

Risk of ruin is typically calculated as a loss probability. Also known as the "probability of ruin."

BREAKING DOWN 'Risk of Ruin'

Risk of ruin is generally identified through advanced financial modeling. It is usually expressed as a probability. The complexity of the financial modeling methodology involved in calculating risk of ruin will typically depend on the number and variety of investments involved in a comprehensive trading portfolio.

Diversification can help to mitigate high risks of ruin. Ultimately most investors will have a threshold level for which capital cannot fall below to avoid unrecoverable losses while still seeking to generate profits. Losing all of an entity’s capital assets can also be costly resulting in bankruptcy and other situations which have their own additional expenses.

Risk management programs can be constructed in various ways and varieties based on the investor and type of investments involved. Risk management programs will vary across disciplines with some standard practices in the financial industry developed for investment management, insurance, venture capital and more. Institutional risk management is typically relied on for all types of investing scenarios in the financial industry while personal risk management can potentially be more easily overlooked or miscalculated.

Estimating Risk of Ruin

In a single asset investment the risk of ruin is usually considered to be a probability that an investor’s entire investment could be lost. This probability is typically generated through scenario modeling that provides a measure of the value to be lost per movement in price or yield leading to total investment losses.

Generally, the concept of diversification was developed to mitigate the risk of ruin. Financial models can be built by risk managers which build on single asset risk of ruin probabilities. Multi-investment models seek to calculate the probability of ruin from each investment. Generally, multi asset portfolios can be extremely difficult to build risk management strategies for because of the infinite number of scenarios involved with investments across a portfolio. For this reason, most investors rely on asset allocation models that invest a base level of capital in risk-free or very low risk assets while taking higher risk bets in other areas of a portfolio.


Investing a large portion of a portfolio in risk free assets is the best way to manage a capital base and mitigate against the risk of ruin. Modern portfolio theory builds out this concept by creating optimal allocations for investors based on their risk tolerance.

Personal investors, technical analysts and day traders who do not strictly adhere to portfolio management theory will likely follow the 2% Rule. The 2% Rule is a well established rule in the investing industry that suggests an investor should not bet more than 2% of their capital on a single investment trade.

Institutional Investment Banks

In the institutional market several occurrences of mismanaged risk of ruin have led to steep losses and even bankruptcy. The bankruptcy of Lehman Brothers and the 2008 financial crisis is one example that had several implications for the market from legislation enacted through the Dodd-Frank Act. The 1995 bankruptcy of Barings Bank provides another example of mismanaged risks that led to detrimental losses for a large institutional bank.

  1. Business Risk

    Business risk is the possibility a company will have lower than ...
  2. Accepting Risk

    Accepting risk occurs when a business acknowledges that the potential ...
  3. Price Risk

    Price risk is the risk of a decline in the value of a security ...
  4. Company Risk

    Company risk is the financial uncertainty faced by an investor ...
  5. Associate in Risk Management (ARM)

    An associate in risk management designation is a nationally recognized ...
  6. Risk Management

    Risk management occurs anytime an investor or fund manager analyzes ...
Related Articles
  1. Insights

    How to Invest In Developing Markets

    Developing markets can be attractive additions to many investor's portfolios, but carry additional risks that must be considered.
  2. Investing

    Diversification: The Right Way to Manage Risk

    Diversifying your portfolio across multiple asset classes will help you minimize investment risk.
  3. Investing

    The Risks Associated with Common Investments

    Investing inherently involves some risk. Here are some of the different types of investment risks.
  4. Investing

    The Importance Of Diversification

    Diversification is a technique that reduces risk by allocating investments among various financial instruments. Learn how to maximize your return without increasing substantial risk in your portfolio.
  5. Investing

    How To Manage Portfolio Risk

    Follow these tips to successfully manage portfolio risk.
  6. Investing

    Balancing the Different Risks Investors Face

    One of the keys to investing successfully is to balance different types of risk.
  7. Managing Wealth

    Modern Portfolio Theory: Why It's Still Hip

    Investors still follow an old set of principles, known as modern portfolio theory (MPT), that reduce risk and increase returns through diversification.
  8. Investing

    Using Logic To Examine Risk

    Know your odds before you put your money on the table.
  1. How does market risk differ from specific risk?

    Learn about market risk, specific risk, hedging and diversification, and how the market risk of assets differs from the specific ... Read Answer >>
  2. What are the major categories of financial risk for a company?

    Examine four major categories of financial risk for a business that represent potential problems that a company may have ... Read Answer >>
  3. What is backtesting in Value at Risk (VaR)?

    The value at risk is a statistical risk management technique that monitors and quantifies the risk level associated with ... Read Answer >>
  4. What are some common measures of risk used in risk management?

    Learn about common risk measures used in risk management and how to use common risk management techniques to assess the risk ... Read Answer >>
Trading Center