How risky are your investments? Are you willing to take more risk in order to possibly earn a higher return, or are you risk-averse and comfortable with a more predictable and steady return?

Either way, here are a few things to bear in mind.

Risk is simply the uncertainty that the return – which an investor actually obtains from an investment – will differ from the return the investor was expecting. Most are aware that the more risk an investor is willing to take, the more he/she has a possibility of earning greater rewards. Therefore, risks are not all bad, nor should they intimidate an investor. Investing simply depends on the investor’s needs/goals, and how much risk they are willing to undertake to achieve those needs/goals. There are many types of risk, all of which fall under the broad categories of systematic risk and unsystematic risk.

SYSTEMATIC RISK

Systematic risk refers to those factors that affect returns on all comparable investments. In other words, systematic risk includes risks that affect the entire market, entire market segment, economy or industry. These types of risks contribute to the day-to-day fluctuations in a stock’s price.

Examples of these risks are interest rate risk, market risk, exchange rate risk, purchasing power risk, political/sovereign risk and so on.

Diversifying the portfolio by acquiring comparable assets does not reduce this source of risk; thus, systematic risk is also referred to as “non-diversifiable risk”. While constructing a diversified portfolio has little impact on systematic risk, it is not to be thought that this risk cannot be managed.

There are techniques that can be used to help mitigate various sources of systematic risk.

For example, inflation is not good for the overall stock market, but some stocks are more inflation-resilient, particularly those of businesses that provide necessities (food, personal care products, pharmaceuticals) or low-cost gratification (alcohol, tobacco). These categories tend to hold their own in inflationary times because people must continue to purchase basic items to live or enjoy affordable at-home

entertainment. Therefore, purchasing securities from these

types of companies can help to mitigate inflation/purchasing power risk.

Another example is, if you realise interest rates are rising, you could sell your stocks and move into newly issued bonds. For further clarification and ideas on how you can hedge against these risks, feel free to discuss with your financial or wealth advisor.

UNSYSTEMATIC RISK

Risks that can be reduced are referred to as unsystematic risk, also called “diversifiable risk”. These are defined as risks associated with individual events that affect a particular security and are therefore dependent on factors that are unique to a specific asset.

For example, a firm’s earnings may decline because of a strike. Other firms within the industry may not be experiencing the same problem with labour, and thus their earnings may not be hurt or may even rise as customers divert purchases from the firm whose operations are temporarily halted. In either case, the change in the firm’s earnings is independent of systematic risk.

Because this source of unsystematic risk applies only to the specific firm, it may be reduced through the construction of a diversified portfolio. For this reason, it is advised to diversify your portfolio, as long as one is able to, by investing in more than one type of security and in different industries.

It is imperative that seasoned investors, those that have just started or those contemplating investing, constantly educate themselves about the various factors concerning investments. This approach will allow them to be more equipped and realistic in investment endeavors.

Specific to this article on risk, it is important that investors not only have a good understanding of their risk tolerance, but to also know which investments match their risk preferences. Investors should also be more open to taking risks in order to potentially make more on their returns.

Making the step to invest is a smart move. The point is to be aware of risks, not to be intimidated by them. Learn to use these risks to your advantage.

Lisa Duncan is a service associate at SSL.