Types of risk in Portfolio Management
June 23, 2021
Types of risk in Portfolio Management
What is risk? Is it venturing into the woods in the darkness of the night? Or driving the car without the seat belt on? Or perhaps flying over a war zone without insurance? As evident, risk means different things to different people. But in the world of investments through portfolio management services, risk means either the loss of money or making lesser than expectations. And to avert or mitigate risks in finances, a sound knowledge of how money works, pros and cons of the market and, its erraticism is a must. Now, risk management becomes all the more imperative when someone else on your behalf takes investment decisions. Which brings us to the risks involved in investments done through portfolio management services.
What is a portfolio?
Imagine an investment portfolio, prepared by a portfolio management service, to be a big apple pie made up of slices of varying size. Now consider each slice to be an equivalent of an asset class and/or type of investment, each of which is suggested and then executed by a portfolio manager, the bloke representing a certified portfolio management service. Several different kinds of securities can make up a portfolio, but cash, bonds and stocks are usually considered the building blocks of any portfolio. Other asset classes include real estate, currency, commodity etc.
Impact of risk tolerance on portfolio allocations
While it’s usually the portfolio manager from the portfolio management service entrusted with developing portfolio models for you, it’s your risk tolerance that will shape your portfolio. If you are a conservative investor, then you can instruct the portfolio management service to opt for large-cap stocks, a position in liquid, high-grade cash equivalents etc. And if you are the risk-tolerant types, then you are most likely to ask your portfolio management service to go for small-cap growth stocks, real estate, international and alternative investment instruments etc.
Impact of time horizon on portfolio allocations
You, as an investor, should also consider the duration of investment when the portfolio management service provider builds your portfolio. You should opt for more conservative asset allocation as you approach your investment goal, in order to safeguard your portfolio’s principal amount that’s been built up to that point.
What are the various risks involved in portfolios?
The probability of fetching lesser returns from investments compels many investors to choose conservative investments. Even for long-term savings. Which is why, it is essential that a trustworthy portfolio management service provider gives you a lowdown on all the risks that accompany portfolio management services. And if you are still concerned that the portfolio management service provider will keep you uninformed, we have categorically listed down various risks accompanying portfolio management services for you. After all, familiarizing yourself with the different kinds of risk is the first step towards learning how to manage them.
1. Market Risk: It is the likelihood of the value of a security moving in tandem with the overall market. Which means, if the stock market is experiencing a decline, the stock mutual funds in your portfolio may decline as well. And if the bond prices rise, the value of your bonds may rise as well.
2. Interest-Rate Risk: Usually associated with fixed-income investments, this is the risk that the price of a bond or fund will fall with rising interest rates.
3. Inflation Risk: It is the risk of your portfolio declining in value as the purchase power of your savings diminishes as a result of inflation. Your portfolio management service provider should prompt you to evaluate conservative investments like bonds and funds etc. You must know that even if your investment posts gains over time, it will lose value if it doesn’t keep up with the rate of inflation.
It is to be noted that the portfolio management service provider will not take responsibility of losses incurred from the above risks, since they are triggered by unforeseen events taking place in a highly dynamic environment. So, remember to consider the impact of risk tolerance and time horizon during asset allocation in the beginning.