Hey folks,


Maybe it’s because of my military background, or maybe it’s because I just don’t like to lose money, but if there’s something I’m hypersensitive about it’s risk.


But what is risk and what does it mean for us, value investors? The book The Intelligent Investor defines risk as a permanent loss of capital.


Understanding risk exposure is important because it dictates what the potential investment returns can be. Higher exposure to risk should mean higher potential returns.


Since no investment is guaranteed, it goes without saying that no investment is without risk. Exposure to risk is present and necessary in all investments.


Going further. The potential for capital loss, or the risk exposure, will change as I open or close a position. Exposure also changes when a position increases or decreases its portfolio weight.


Risk Analysis – Central to Value Investing

Since exposure is dynamic, then its assessment is an on-going process. It’s also an essential process, it allows me to determine the best way to balance off the risk exposure with the potential rewards of the investments. In cases, dramatically reducing the exposure while keeping the potential investment returns.


Exposure to risk is tied to specific risk factors. By knowing the risk factors associated with my type of growth portfolio I’m able to identify the worst case scenarios.


And knowing these scenarios, more importantly, planning a contingency for them, helps me keep my sanity when financial markets are in turmoil and there is general investor confusion. It also allows me to sleep pretty calmly at night.


The First Step in Risk Analysis

I’ve previously written an article which covered my investment risks in a single position, the oil stock ETF, iShares S&P/TSX Capped Energy Index ( ticker:XEG.TO). However, there are much broader risk factors that cover all the investments I hold.


My first step in a risk analysis is to identify the investment risk factors I’m exposed to. Step two is to assess how much risk each factor brings into the portfolio. That, and subsequent steps, will be covered in follow-up articles.


Though the investment risk factors listed below apply to my particular portfolio there is crossover with most retail investors. To be clear, I’m not reinventing the wheel here. The factors and their definitions are standard for the financial industry.


So, without further ado.


Top 9 Portfolio Investment Risk Factors

1. Concentration risk: The risk of loss as a result of lack of proper diversification.

2. Credit/Default risk: The risk that an ETN issuer or third party will default, meaning not repay the principal or interest as promised.

3. Foreign investment risk: The risk of loss when investing in foreign countries.

4. Horizon risk: The risk that the investment horizon may be shortened because of something unforeseen.

5. Inflation risk: The risk that the value of assets will be diminished as inflation eats away at the value of the currency.

6. Liquidity risk: The risk of being unable to trade the investment at a fair price and get the invested funds when needed.

7. Longevity risk: The risk of outliving the income generated from the assets.

8. Market risk: The risk that the price of the investment will fluctuate as a result of changing political, economic, market or company conditions or situations.

9. Reinvestment risk: The risk of loss from reinvesting principal or gains at a lower interest rate or rate of return.

Reacting Rationally to Real Risk is one of a Value Investor’s Secret Weapons

My portfolio strategy is based on balancing off these risks, assessing the amount of exposure, with the potential rewards. That will be the subject of a future post.


The Securities and Exchange Commission (SEC) has a pretty solid intro to investment risk, as does the Financial Industry Regulatory Authority (FINRA).


The reality is, your particular set of circumstances is certainly different from mine and other value investors. That being said, if you’re unsure about risk in your portfolio, then you should seek the assistance of an investment professional.


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