The Meaning of Risk

Generally defined as a hazard, danger or peril, the notion of risk when viewed in the context of investment, can take on different meanings. Indeed, given the arbitrary nature of this subject, individual investors can struggle to ascertain what exactly is their appetite for risk. Interestingly, while the English interpretation is generally associated with negative connotations, the Chinese definition emphasises an opportunistic element.

As such, risk should be perceived as a choice rather than a fate and the key challenge is not to take on a greater level than is required to generate the return that is desired. Investors may be attracted by the possibility of blue-sky returns associated with high risk equities, leading to a profound concentration on just two or three stocks. However, this strategy yields the potential for substantial under performance if any one of the holdings experiences a setback.

Therefore one of the best ways to manage investment risk is to diversify, or spread this risk, over a variety of investments. For example, specific events can have a dual impact on equities, so what may prove positive for one company may be negative for another. For example, oil companies such as BP Amoco and Shell typically benefit from oil price increases whilst simultaneously airlines such as British Airways and Ryanair, heavily dependent on oil, suffer as a result of such price action. It is only by applying a balanced approach in terms of geographic, sectoral and stock spread, that one can reduce the sensitivity of your portfolio to individual influences.