It can be hard to predict the future, and that is especially true when it comes to investments. While some investments may seem like a sure thing, there is always risk involved. It’s important to measure and understand the risk of any investment before you put your money in it. There are many ways to measure and predict risk, but they can seem complicated and overwhelming.
We’ve broken it down for you:
Non-market Risks
Non-market risk is the risk of losses that are not caused by changes in market conditions. These risks can come from factors such as weather, natural disasters, political instability, and regulatory changes. Non-market risk can also arise from company-specific events, such as a change in management or a new product launch.
There are a number of ways to measure non-market or specific risk in stocks. One way is to look at the overall volatility of the stock. This can be done by looking at the standard deviation of the stock’s return over a period of time. If the stock is more volatile, it will have a higher standard deviation and will be considered riskier. Another way to measure specific risk is to look at the beta of the stock. Beta measures how volatile a stock is in relation to the market as a whole. A high beta means that the stock is more volatile than the market, while a low beta means that it is less volatile. Finally, another way to measure specific risk is to look at the industry in which the company operates. Companies that operate in industries that are prone to regulatory changes or other industry-specific risks will be considered riskier than those that operate in more stable industries.
Market Risk
Market risk is the risk that a particular stock’s price will be affected by overall stock market movements. This type of risk is also sometimes referred to as “systematic risk.” Market risk cannot be diversified away, which means that it affects all investments to some degree. For example, even if an investor owns a well-diversified portfolio of stocks, she is still subject to market risk. However, certain investment vehicles, such as index funds, can help to minimize this type of risk.
Beta and standard deviation are also useful to measure the market risk of a stock. A stock with a beta of 1 is expected to move in line with the market, while a stock with a beta of 2 is expected to move twice as much as the market. As a result, beta can be a useful tool for measuring market risk. A higher standard deviation indicates greater market risk, as there is a greater likelihood that actual returns will deviate from the expected return. To calculate standard deviation, you will need to first compute the variance. The variance is calculated by taking the sum of the squared differences between each data point and the mean, and then dividing by the number of data points. Once you have computed the variance, all you need to do is take the square root to arrive at the standard deviation. While calculating standard deviation may seem like a daunting task, it is important to understand this concept in order to make informed investment decisions. By understanding how to measure risk, you can ensure that your portfolio is well- diversified and positioned for success.
We would be glad to help you measure and manage the risk in your portfolio. Give us a call today!
*Any opinions are those of Roy Gray and not necessarily those of Raymond James. The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material and does not constitute a recommendation.
Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Past performance may not be indicative of future results.
How to Measure the Risk of an Investment
