INVESTMENTS
TERMS
Managing Investment risks
The term "market risk," which also goes by the names "systematic risk" and "non-diversifiable risk," describes the possibility that an investor's portfolio value will fall due to factors external to the investor but inherent in the market as a whole. It includes things like interest rate fluctuations, GDP growth, inflation, global politics, and market sentiment.
All investments in the market are vulnerable to market risk. This is in contrast to company-specific risks, which can only affect a single business or industry (these are sometimes called "unsystematic" or "diversifiable" risks). Market risk cannot be diversified away like other types of risks can.
Let's pretend John is a stock investor and use his situation to talk about market risk. Let's say John has invested in XYZ Corporation and now owns shares. XYZ Corporation stock price is affected by market forces. The stock price of XYZ Corporation, like the stock price of most companies, could fall if the market experiences a downturn.
Let's move on to some calculations and a concrete example to better demonstrate market risk. Let's pretend John put $10,000 into an index fund that replicates the stock market. The value of an index fund varies throughout the course of a year. The value of the index fund at the end of the year is $9,000.
The following formula can be used to estimate either the rate of return on an investment or the market risk of that investment.
The potential loss in value due to fluctuations in the market is calculated as:
The potential danger in the market is:
(9,000 - 10,000) / ($10,000 - 10,000) = -0.1, or -10% Market Risk
A decrease in worth is represented by a negative sign. John lost 10% of his investment due to market risk that year.
Gains on investments are possible thanks to the possibility of positive returns from exposure to market risk. Market risk is the degree of uncertainty and the range of possible outcomes associated with the broader market.
To sum up, market risk is the potential for a decrease in investment value as a result of factors outside of an individual investor's control in the market as a whole. All investments are vulnerable; even spreading your money around won't help. Investors can better manage their portfolios and make educated decisions when they have a firm grasp on market risk.
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