The Importance of Portfolio Risk Management in Business

Most people equate “risk” with something that is negative in form, and in the context of business and investment would automatically give them an image of losing life savings. Business risk comes in many forms and your financial goals can be affected in your pursuit of each. Learning to manage them would be the key to deal with financial risk.

Identifying the Kinds of Risk

One of the best ways to do portfolio risk management would be to identify the different investment risks, which are as follows:

  • Interest-Rate Risk – This is often attached to fixed-income investments, where the risk involved would be the event of rising interest rates which will lower the price of a bond.
  • Credit Risk – It is to take the word of a bond issuer to repay the debt as soon as the bond matures. A higher rating means lower credit risk. Junk bonds have higher yields but also are the riskiest because of such lowest ratings.
  • Market Risk – The overall market value of a stock or bond will go along with the current market price. If stock markets are on a decline, mutual funds go down as well. If bond prices go up, the bonds in your portfolio will likewise follow.
  • Inflation Risk – Inflation may lower the purchasing power of your savings and this decline will also affect the value of your portfolio. Long term investments in bonds, money market funds and bond funds may show gains after some time but will also lose value if it does not keep pace with the rate of inflation. Money market funds are not guaranteed or insured by any government agency and the Federal Deposit Insurance Corporation.

Portfolio Risk Management using Diverse Investments

Diversification may be a key to minimizing the risks to your investment. Mutual funds can be an ideal way of diversifying because of their investment in different securities. Investing in more than one mutual fund will also lessen the risk.

Evaluating your savings goals will help you decide on the types of investments that will work from a risk perspective. You have to question yourself whether your goal is to generate income to cover for current business expenses, building the principal’s value over and above inflation or preservation of your business capital. Your answer to these questions will help you find the balance between the risks you are willing to undergo and the return on investment that you hope to get from your enterprise.

Adam Wilson