Determine Risk in an Investment

Investing and the risk factor

The general or overall aspect of risk typically involves an expected value or outcome of a particular future event. Those values can be either negative or positive. The concept of risk is oftentimes generalized with unpredictability factors and focuses on failing to attain a positive benefit as well as the potential for harm (negative outcome) that exists. The risk concept itself becomes a bit more technical when you are discussing investment risk and the stock market.

The risk factor and the stock market

Taking the assurance of some type of return into consideration, there are only two types of investments – those that are riskless and those that are risky. The key difference is that riskless investments are guaranteed, whereas risky ones are not. However, always remember that the guarantee is only as valuable as the guarantor who makes it. Additionally, the only investments which are considered as being riskless are those that have been backed by the confidence and faith of a large national government that is stable.

Despite this, you still need to be aware of the fact that the risks of currencies devaluating based on inflationary trends is another form of investment risk which is most commonly referred to as “inflation risk.” Therefore, you cannot refer to any investment as being totally risk-free although it may be backed by what is currently a stable government. When all else fails, try to remember the cardinal rule that applies to investing in any financial instrument – never risk more money than what you can afford to lose.

Calculating investment risk

Part of the education phase of investing when you are just starting out involves learning how to calculate investment risk. Remember first and foremost that risk is an inherent factor with any type of investment, whether there is a no-risk guarantee or not. One of your greatest assets could very well turn out to be non-monetary but rather your ability to assess that investment risk so as to minimize it in your portfolio.

6 steps you can take to determine investment risk

There are a number of ways that you can educate yourself so that you can determine what the risk factors entail with numerous types of investments. Here are 6 steps you can take for how to determine risk in an investment:

1. Investigate the current conditions of the market – review investments that are considered to be risk-free

2. Look for rates of return that are close to what is desired

3. Take the anticipated return rate and deduct the baseline investment

4. Determine what the prior year’s return was on that investment – use the following formula –

“The total Return equals the Year-End Value minus the Year Start Value
plus the Dividends and divide that by the Year Start Value”

5. Compare the investment standards to the risk premium in order to calculate the potential ROI

6. Learn the correlation between the way in which risk compares the total loss of the principal investment to the actual type of investment involved