A risky world

By Randell Tiongson on January 29th, 2011

Here’s a guest post from Melvin Esteban. Excellent writer!

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A Risky World

Filipinos are generally conservative. Surprisingly though, you’ll still hear a lot of people losing so much money on the investment that they bought. In all the talks that I had, I’ve always been asked what investment do I best recommend that will give good return without taking risk. Well, bad news is, this investment don’t exist. Even your friendly and safe “Time Deposit” or “Savings Account” is not totally risk free.

No matter how you fix your investment and regardless on how much you diversify it, you can never remove risk. To better understand, there are two kids of risk. The risk associated with your investment (as an investment or a whole portfolio) has two components.One (unsystematic risk) can be diversified away, and the other (systematic risk) cannot.

Unsystematic Risk

Good news is, this can be diversified. This type of risk is very specific to the asset you bought (firm specific).

Say for example there was a massive recall of product produce by the company you invested because they found out it was tainted with poison or say the company unexpectedly in a deadlock with his labor union or even as simple as the a warehouse catching a fire.Financial risk will also be high if the company has high level of debt and Business risk will be elevated if investment is only concentrated to few industry or asset class.

You can eliminate this by simply just adding different investments and class of investments. This risk can be reduced because the other asset in your portfolio can offset the unsystematic risk associated with that asset. If poorly set up though, you may still end have a high unsystematic risk while a well set up will eliminate this risk.

Systematic Risk

This risk cannot be removed nor diversified away. This risk is market related compared to the first one that is firm specific. Market related may be the macro economic variables.

Examples of such macroeconomic forces are unexpected changes in the country’s growth rate like GDP and GNP, consumer price index, industrial production, interest rates, exchange rate, or even the money supply. In cases like this, your entire portfolio will be affected. Though an asset may be affected more than the other, overall, there is no way for any investment to escape from the impact.

The combination of the unsystematic risk and systematic is the risk total risk your portfolio. As mentioned earlier, unsystematic risk can be diversified and removed. So if properly done, what will be left is still the systematic risk.

So next time somebody tells you that the investment that they are offering is a sure thing! You may want to think twice.

HAPPY WEALTHY LIVING!

Melvin J. Esteban, RFP, CFC, FLMI, ACS is a contributor for Income-Tacts.com, the country’s premiere personal finance on-line community dedicated to the financial literacy of Filipinos. He is also the President of Motivating Minds, a consulting company. To write the author, send e-mail to [email protected]

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A risky world