What are “good” and “useless” risks?

Last Updated on 23, March 2014

It has been said to get potentially higher return, one must take risk. This is not entirely correct. There are two main sources of risks namely systematic and non-systematic risk.

Systematic risks are those which affects the entire broad market. Examples are interest rate risk, money supply, political risk, etc.

Non-systematic risks are those which are peculiar to the company concerned and does not affect the broad market. Examples of non-systematic risks are fraud, mismanagement, accounting "creativity", insider trading,etc.

Research has shown that taking on non-systematic risks do not translate to a potentially higher return in investments. Those who invests in a concentrated portfolio of stocks and bonds expose themselves to high non-systematic risk.

To eliminate non-systematic risk, diversification is the usual way to do that. Once non-systematic risk is eliminated through diversification, what is left is the systematic risk which research has shown to be the risk that translate to higher potential return.

Like this article? Subscribe to my newsletter below for more.

Get regular Tips on Financial Planning. Free subscription for 3 years. Covers all aspect of financial planning such as 'How much salary you should have?', 'How to avoid insurance that is not suitable?", 'What are the retirement planning methods?", etc

Name:

Email: