What is a Specific Risk?
Also known as an unsystematic risk, a specific risk is some risk factor that has the potential to affect the performance of a small number of assets contained in the investment portfolio. A risk factor of this type may be an unforeseen occurrence, such as the sudden resignation of a key executive in a company, a surprise outcome in a political election, or even a natural disaster that affects a given industry. With a diversified portfolio, it is possible to minimize the impact of a specific risk on the overall value of the investor’s assets.
While there is some degree of risk involved with any investment, a specific risk normally does not have the ability to impact an entire market. More commonly, the risk factor may affect the performance of one or a few securities that are connected with that market. In terms of duration, the risk may cause the value of those few securities to remain stagnant or even drop for a short period of time. Should an event occur that seriously cripples the ability of a business to continue operations, that specific risk may create a permanent loss for any investor who owns shares issued by that company.
Due to the potential impact of a specific risk, many investors choose to diversify their portfolios in several ways. One strategy is to acquire securities that are connected with a wide range of industries. This helps to minimize exposure should some particular risk have an adverse effect on a few companies in a given industry. Investors may also broaden the diversification by including different types of investments within the portfolio, taking care to maintain a certain ratio between those security types. For example, an investor may include bond issues, commodities, futures, and stock options in the combination. With the stocks and bonds, the investor may choose to purchase bonds from government entities as well as businesses, and make sure that the stock options represent several different industries that are not directly related.
Taking steps to minimize the effect of specific risk leaves the investor less vulnerable when an employee strike occurs, or a hurricane destroys manufacturing facilities. Political events will also have less influence on the overall value of the portfolio, even though situations of this type may have a profound impact on one or two of the assets currently held by the investor. With the right mixture of assets, it is possible to offset any losses incurred on the few securities that are adversely affected with the continued high return that is generated from the other assets in the portfolio.
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