Many investors view risk as the prospect of losing money in a market downturn. The investment industry uses statistical concepts like standard deviation and beta to define investment risk, measuring the degree of uncertainty of the expected return of your investments over time – both up and down. The most common form of investment risk includes: Market, inflation, credit (default), interest rate, currency and timing.
From a financial planning perspective, however, the most appropriate definition of risk is the uncertainty of falling short of your financial goals, such as retiring early on a sufficient income or adequately funding your children’s higher education goals.
While investment risk can be managed but not eliminated, avoiding investment risk entails it owns sets of risks, namely your capacity to realize your long-term financial goals. Traditional financial planning solves for your absolute highest risk tolerance and then recommends an investing plan to experience it. Wealthcare planning assumes that you would take even less risk than your maximum risk tolerance if it would satisfy your most important financial goals.
Once your appropriate risk profile has been developed, investment risk is best managed through good portfolio diversification - dividing your investment dollars among different industries, countries, and asset classes (stocks, bonds, cash, real estate, etc.). "Spreading the risk" through portfolio diversification will cushion the impact that a problem with a single investment might have on your entire portfolio.
