How To Measure Investment Risks
Most people think about risk as being a really negative thing when the truth is that it is something that simply needs to be taken into account by businesses because every single investment does have some sort of associated risk. We have necessary risk, bad risk and good risk. A possibility of measuring the risk will often be the difference between failure and success, especially when referring to companies that make their first investments.
One of the most used of the absolute risk metrics at the moment is known as standard deviation. It is a statistical measure of dispersion, calculated round central tendency.
Psychology And Risk
The concerns that investors have are quite simple. Most are concerned that the money that they invest will not bring in profits. There is what is known as loss aversion. This means that when a loss appears, the investor is disheartened, thus making a measurement even more important.
It is really important to present documents that highlight how much assets can deviate from expected outcome. This is what highlights whether or not there is a huge risk that is associated with the investment. We have value at risk (commonly referred to as VAR), which is really important for investors.
Active And Passive Risks
We have beta as something that is used to measure whether or not a mutual fund will beat S&P 500. You will see this listed as systematic risk, non-diversifiable risk or market risk. If the beta is higher than 1, you are faced with more risk than market average.
Factors That Influence Risk
There are various factors that influence risk. This is where everything becomes complicated. Investment managers will always calculate as many risks as possible, including country, sector, stocks, charting and fundamental analysis.
We have a clear view towards alpha, which is a measure of excess return. Alpha can be defined as being the portfolio return that is not explained through beta, highly represented by a distance between x and y axes in investments with y intercepting, thus leading towards a negative or a positive. As an example, an investor can believe that energy sectors will outperform other sectors. In the event that the energy stocks will decline because of unexpected economic developments, the investment will underperform.
In most situations you will need to pay more for exposure as you are more active with investments. It is quite difficult to differentiate between active and passive strategies when referring to pricing. In most cases investments end up building a diverse portfolio that includes both actives and passives. It is a really good idea since this basically minimizes all risks.
As you can easily notice, we did not highlight how to actually calculate risks but we did highlight some facts that are of extreme importance. Since you are here and you read till now, there is a pretty good possibility that you cannot actually calculate all risk factors alone. With this in mind, it is really important that you talk to someone that has a lot of experience and that can easily help you to properly calculate risks.