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risk / risk tolenrance

One of the most talked about factors in investing is risk, and the tolerance you have to carry the same.

Put simply risk is seen as the possibility that an investment will not return what you have planed, or even be smaller afterwards…where “smaller” can go all the way down to zero.
(Buy one stock, like Enron, and you can lose all your money in no time at all. Even worse; invest into some derivative products or leverage you investments with borrowed money, and you might end up well below zero….)

But risk should not be viewed as just bad, as it is just the other side of the coin called “return”. By shouldering more risk you are also opening up the possibilities that you can garner more in returns.
But beware - the rule cuts both ways. If you are after bigger returns you will have to take on a bigger risk.

Consider the differences between stocks and government-backed bonds:
The government bonds will not fail you, at last not as far as can be safely judged, and therefore carry very low risk, but they will not deliver returns to get dizzy about.
Stocks on the other hand are sometimes capable of returning heady returns, but just as likely will make you squirm when they move sideways for years on end, or lose 20% or more in a lousy year / month / week / day / hour…

As for your tolerance to carry risk: it is manly defined by how long your time horizon is, and how well you can sleep with a book loss of 30%.

Risk and return are intertwined for good, so should someone offer you an investment promising big returns at absolutely no risk… utter some quieting words, step back, turn around and then don’t walk but run, as fast as you can.

Also some of the risk of your portfolio can be diversified away, by not putting all your eggs in one basket.

By the way; even though there is no “correct” measurement for risk a figure that is most often associated with it is the standard deviation, a statistical concept to show the “swings” the performance might make.

For more exhaustive reading regarding "risk" you could go a have a look see on Morningstar’s risky business series.

For a more mathematically correct definition of standard deviation you could have a look into a good statistical course book, or maybe on Robert Niles homepage.