One of the most important portions of portfolio risk management is to avoid losing money. Understanding this risk involves assuming how to reduce this risk, which separates successful investors from those who never make money.
Portfolio investment risk is of several types. Knowing risk is the first step in making better investment decisions.
Macro Risk Categories
There are two types of risk in the macro sense. A systematic risk, also known as market risk, is a risk to the entire market. An example of this is the general tendency of the stock market dictating a significant part of the total yield. In this case, owners of stocks from different sectors do not diversify the market risk of the market.
Reduce your systemic risks by covering your positions with non-correlated assets (making it much more difficult than most) or using good stop management techniques to retain capital. Although stoppages are not part of modern portfolio theory, their use and part of their overall strategy.
Changes in interest rates, recessions and major disasters are examples of systemic risk because they affect the entire market. Non-systematic risk, also known as specific risks or diversifiable risks, is the risk inherent in each investment. Investors can adequately diversify the specific risks. For example, if you put all your money into a biotech company that has just received news that the FDA does not accept a new drug, you will experience an unusual or specific risk. This news would result in a fall in the share price due.
If you owned more biotechnology companies or even better companies in other industries, you would have reduced your risk. Jim Cramer's "Mad Money" program has a segment "Changed?" People call and give him five sets of stocks that are in different industries. Where there is a huge diversity in the portfolio, he writes. Everything you do suggests how to cover the non-systemic risk. Systematic or market risk remains in the capitals.
Popular S & P 500 index funds are exposed to market risk while diversifying the specific risk of ownership of a particular stock or sector. On January 4, 2000, the $ 10,000 invested in the S & P 500 Index Fund would be worth $ 9,373.09 on November 30, 2009. This is the impact of an investment portfolio on systemic or market risks. The diversification of the broad S & P 500 has not prevented money. Rather, you felt that the possession of the market strikes, but with the use of appropriate hedge techniques, it would reduce or completely eliminate the effect of market losses.
When examining a complete portfolio, you must consider important factors that include your most important core elements. Dr. David Swensen, the Nobel Prize winner of Economics, identified the three characteristics of basic assets that should be part of their valuation to reduce systemic or market risk.
o Use devices to cover the market risk of other devices. For example, real estate is a good defense against inflation, while bonds provide protection against financial crises. Recognizing the inherent characteristics of its core assets, it can cover the market risk inherent in the investment portfolio.
o Fundamental market returns are needed from the asset class. If it only depends on active asset management, it increases the risk of losses if it does not invest in the market.
o Fluctuate in liquid markets where there is a ready market to buy and sell its essential assets. Devices that can not be sold at an instant price are sudden and profound losses. Liquid markets give you the ability to apply stop-loss techniques when the market is turned against it as a recession.
Portfolio of the stock is part of the entire asset valuation, which includes vacancies, real estate, bonds and possibly precious metals. Taking this broad perspective, you have a better chance of using general hedges that do not correlate with market risks.
The most effective method for modern portfolio theory is the optimal combination of asset classes that create the highest risk profile.
By having assets that do not correlate with each other, you can reduce the risks inherent in the portfolio. In general, stocks and bonds show a negative correlation. When stocks are performing well, bonds are not, and when bonds are performing well, inventories do not.
Market sectors show a different level of correlation. Possessing non-correlated sectors contributes significantly to reducing the risk. For example, stocks are closely related to their sector. In this case, it is better for an investor to be the sector rather than the individual. Holding this sector helps to achieve diversity by reducing the specific risk of stocks.
By possessing asset classes that do not correlate with one another, you can reduce your risk. The most important asset classes are:
o bonds, equities, real estate and cash common assets
o geographies including the United States, the European Union, the United Kingdom, Japan, China, India, Brazil and Latin America, The rest of Asia, the Middle East.
o Bond types such as treasury bills, corporate short or long-term
o major currencies, including US dollar, British pound, euro, Japanese yen
If asset classes you're less likely to correlate with each other, it reduces the risk in your portfolio. Many investors do not take this into account when they build their portfolios. Using the R-squared factor, correlation 1 indicates that asset classes are perfectly correlated with each other. A zero correlation coefficient indicates that there is no correlation in the performance of the asset classes.
For example, S & P 500 and Russell 2000 approximate a 0.97 correlation. Where the average correlation between S & P sectors is 0.32.
Asset allocation is the most important factor in building a high-performance portfolio. Taking into account the risk of each asset class, you can create a portfolio that can break the market in good times and bad.
Source by sbobet