Are you building your portfolio the right way to reduce your risk exposure? There are two types of risk every investor should be aware of – Market Risk and Company Risk. Each of these risks effects your portfolio in a different way. Considering the volatility of the market, it’s important that you reduce all the risk you can.
Market Risk
- Everyone investing in stocks is exposed to market risk (also called systematic risk). This is the risk of being in the market. Situations that affect market risk are earthquakes, terrorist attack, economic conditions, and other events that would affect all industries alike. The only way to lessen your exposure to market risk is by the use of derivatives – a very complex trading strategy.
Company Risk
- This risk is specific only to a particular company (also called unsystematic risk). Only investments made in that company will be affected by this risk. Company Risk includes situations like declining sales, loss of customers, a lawsuit, recalls, etc. The good thing about company risk is that it can be diversified away. Meaning if you hold a portfolio of stocks, instead of just one, your risk will be spread out among all stocks, eliminating this risk from your portfolio.
How to Reduce Exposure to Company Risk
Buy more stocks for your portfolio! Around 30 different stocks should do the trick! It’s important they are randomly selected because you don’t want to be bias to only a few industries. That will lead you not being diversified properly.
It’s best to have stocks that are inversely related – meaning the same news affects each stock in the opposite way. So if these stocks were in your portfolio one would go up and one would go down. Keeping the overall balance close to the same. Now in real life the inverse relationship will not be perfect, one stock may go down more than the other one goes up, but either way it reduces your company risk.
In conclusion, as you continue to add more stocks to your portfolio, you reduce your company risk. When you get around 30 different stocks your company risk will be gone and you will be left with just market risk. Your portfolio will be exposed to less risk and your investments will be in a good position to grow for the long run.
