Did you know some investment risk can be eliminated and the remaining risk can be minimized?
What is Investment Risk?
There are two broad types of investment risk. Company and Market. We want to make you aware of these risks and also provide practical solutions to protect your wealth.
Company risk can be significant. This is the risk of one company going broke. Fortunately, this risk of losing everything can be eliminated.
The saying goes, a picture is worth a thousand words, or in this case, a story. In 1997 headline news around the world touted the largest gold find in history by a Calgary based mining company called Bre-X1. This later turned out to be a scam that inspired the 2016 movie GOLD (starring Matthew McConaughey).
The Saskatchewan based Public Employees Pension Plan (PEPP) held Bre-X stock that became all but worthless overnight. Most employees with money in the pension plan likely never knew, as the pension plan’s return that year was actually quite good. The reason everything was fine is that Bre-X accounted for a very small portion of the overall fund. The other unrelated holdings did well that year, easily washing away the tiny loss. Conversely, if you had all your money in Bre-X stock, you would have been wiped out.
The point is that this risk can be effectively eliminated by simply diversifying. In fact, a Nobel prize was awarded proving that point2.
This is the risk of the entire market moving up or down. Although the potential losses can be significant, the above noted Nobel prize proved it impossible to lose all your money. It can however take a long time to recover, thus the importance of your investing time horizon. The important distinction is that a broad market cannot go to zero in contrast to company risk.
Although you can not eliminate market risk, you can reduce it by simply diversifying. The “not all your eggs in one basket” idea. A portfolio that contains parts that complement each other can smooth the investment ride. For example, holding equal parts of two investments that act oppositely, would be the equivalent of the average height of two people on a teetertotter. As one side goes down, the other side goes up. The average would remain the same.
There is no perfect diversification that allows your investment to never experience downside, but matching your comfort level to an appropriate investment has been proven possible and the industry has adopted this as a standard approach.
Now you know what investment risks there are, and that these risks can be either eliminated, or minimized. Hopefully, through knowledge, your investing comfort level has also increased.
If you have any further questions, or just to learn more, please feel free to contact us.