A Risky World
By Melvin Esteban
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 which investment do I best recommend that will give good return without taking risk. Well, bad news is, this investment doesn’t exist. Even your so-called safe “time deposit” or “savings account” is not totally risk free.
No matter how you fix your investment and regardless how much you diversify your portfolio, you can never remove risk. To better understand, there are two kinds 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 a product produced by the company you invested in because they found out it was tainted with poison. Or say the company unexpectedly got into in a deadlock with the labor union. O even as simple as a warehouse catching fire. Financial risk will also be high if the company has a high level of debt and business risk will be elevated if the investment is highly concentrated on a few industry or asset classes.
You can eliminate this by simply just adding different investments and asset classes. This risk can be reduced because the other assets 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-setup portfolio 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 risks refer to macroeconomic 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 risk is the total risk in 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!
