How to Assess and Mitigate Portfolio Risk

Portfolio risk is one of the greatest challenges for any investor. More ambitious portfolios can generate greater rewards, creating more wealth in a single year than cautious portfolios can provide over several years of investing. However, they can also lose these gains in an instant if the market turns volatile. That is why stable and steady portfolios can help protect your money, keeping it relatively safe from market downturns and other unexpected events. It is important to remember that they grow slowly, so they may not deliver the returns you need to meet your financial goals. Managing risk is critical for any investor, especially given ongoing market fluctuations. The right strategies can help you get it right.

Do you have questions about how risk can affect your investments? Consider speaking with a financial advisor.

Assessing the Types of Risk

The most important step in assessing portfolio risk is understanding the types of risk you face. For a retail investor, it’s often helpful to think of risk as three broad categories: asset risk, systematic risk and portfolio risk.

Asset Risk

Asset risk is the risk inherent to any given asset you invest in. It depends entirely on the individual investment so it can differ widely in both degree and kind.

For example, the asset risk of a stock tends to be relatively high. Stocks are relatively volatile investments that can move quickly with the market, and their risk profile depends strongly on the underlying company. A stock can carry risks including regulatory changes, tax changes, corporate governance issues or even the CEO’s Twitter account. All of these factors affect the value of your investment, thus creating additional forms of risk.

Meanwhile, a bond has a very different risk profile. They tend to be relatively stable, low-yield investments, with most of the risk stemming from the likelihood of default on the bond’s underlying debt.

To understand these risks, you must first understand the specific assets that make up your portfolio.

Systematic Risk

Systematic risks are risks inherent to every asset in a given market.

For example, a stock market downturn would be considered a systematic risk, as it would likely affect the value of most stocks. Other issues considered systematic risk include inflation, Federal Reserve interest rates, legal changes and any other external factors that could affect the value of all your investments simultaneously.

Portfolio Risk

Risk is an inherent part of investing, and some portfolio risks are just unavoidable.

For instance, retail investors almost always encounter currency risk. Most individuals invest primarily in their domestic currency, such as the U.S. dollar for American investors. This means their portfolio’s value can fluctuate with currency movements. Unless you venture into international markets, which can be risky for retail investors, there’s often little you can do to mitigate this.

That said, your portfolio’s asset allocation also plays a significant role in determining its risk profile. A portfolio concentrated in specific industries may be vulnerable to industry risk if those sectors experience a downturn.

Similarly, a lack of diversification can lead to concentration risk, while limited growth-oriented investments can result in stagnant portfolio value.

Mitigating Asset Risk

The best way to manage asset risk is through diversification.

The most effective way to manage asset risk is through diversification.

Each type of investment comes with its own unique risk profile, such as these:

Stocks offer the potential for high returns but carry the risk of significant losses.
Mutual funds provide stability and confidence but may not always yield the returns needed to meet your financial goals.
Bonds, while reliable and steady, can lead to substantial losses in the rare event of failure.

To mitigate these risks, consider diversifying your investments across a variety of asset types. Focus on assets with counter-cyclical behaviors that tend to perform well under opposing market conditions. For example, stocks and bonds often exhibit counter-cyclical performance: bonds generally perform better when stock markets decline, whereas a strong stock market can suppress bond values.

By diversifying your investments across different asset classes, you can balance risk and reward, leveraging the strengths of one asset to counteract the vulnerabilities of another.

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Mitigating Systematic Risk

Your portfolio is likely exposed to high systematic risk if it is heavily invested in a small number of specific markets or industries.

For example, if you are mostly invested in the stock market or have most of your money tied up in real estate, you likely have a high exposure to systematic risk. Anything affecting those markets will also probably affect most of your money.

There are a few good ways to manage systematic risk. First, spread your money across several different markets. Perhaps the best way to do this is by investing in mutual funds and exchange-traded funds (ETFs). These bundled products can give you exposure to a wide variety of markets at the retail investor level.

Attempting to invest directly in the commodities market, foreign exchanges or short sales can often be dangerous for an individual investor. However, doing so through a mutual fund can give you diversification without the risks inherent to highly complex investments.

Just as importantly, take a long-term investing strategy. Systematic risk tends to move in waves, but markets generally regain their value over time. It is hard, if not impossible, to completely protect yourself against marketwide risks on a month-to-month basis.

However, if you have built your portfolio around long-term investments, you may have the time to let them recover their value once a specific crisis has passed.

Mitigating Portfolio Risk

Perhaps the most straightforward way to manage portfolio risk is to invest cautiously.

This does come with a caveat: the risk of under-investment is real. You do need to balance your investment decisions with your long-term financial goals. It is completely safe to put the college fund entirely into Treasury bonds and a savings account, but those interest rates probably won’t generate enough return to pay for the kids’ tuition. Investment returns matter.

But in general, the greatest risk to your portfolio is losing money, not missing out on gains, so invest cautiously. Build a well-diversified portfolio with assets weighted toward relatively conservative products, such as mutual funds and indexed products. You should have a segment of your portfolio for speculation on products like individual stocks.

If you are worried about portfolio risk, first check whether you are heavily concentrated in certain markets or industries. Then look to see how much money you have tied up in high-risk/high-reward investments. As common issues, these are good places to start when you want to reduce your overall levels of risk.

How to Measure Portfolio Risk in Practice

Measuring portfolio risk starts with basic statistical metrics that describe how returns behave over time.

Standard deviation reflects how widely returns vary from their average, indicating how frequently a portfolio experiences large swings.
Beta measures how closely a portfolio tracks a broad market index, indicating sensitivity to market-wide changes.
Maximum drawdown shows the largest peak-to-trough loss over a given period, illustrating how much value a portfolio has lost during past declines.
Concentration analysis provides another view of risk by examining how assets are distributed. A portfolio heavily weighted toward a single stock, sector or asset class carries higher exposure to specific events affecting that area. Reviewing the percentage held in the top positions, industries or asset categories highlights whether performance depends too heavily on a narrow set of outcomes.
Geographic and currency exposure also affects portfolio risk. Portfolios focused primarily on one country or currency rise and fall with economic conditions tied to that region. Holdings spread across multiple regions introduce exposure to foreign markets, interest rate policies and currency movements. Tracking these exposures clarifies how external factors influence portfolio value.
Scenario analysis evaluates how a portfolio reacts under different market conditions. Historical stress periods, such as equity market declines or rapid interest rate increases, provide reference points for potential losses. Applying past market events to current allocations shows which assets tend to decline together and which provide offsetting performance.
Risk measurement also depends on your time horizon. Short-term goals are more sensitive to volatility and drawdowns, while long-term goals can absorb interim losses if recovery time exists. Comparing portfolio risk metrics against expected holding periods links numerical risk measures to real financial objectives.

Bottom Line

A woman reducing her risk of injury by attaching a safety harness.

Managing risk is an essential skill for any investor. This enables investors to strike the right balance between overreaching and putting their assets at risk, and under-reaching and thus forgoing capital appreciation. Begin by analyzing whether your risk comes from individual assets, your portfolio allocation or the market at large. Often, the best solution is to diversify so your money is not overly exposed in any single direction. On the other hand, there is an opportunity cost to avoiding all risk.

Tips for Managing Risk

Consider talking to a financial advisor about managing your portfolio’s risk. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When it comes to investing, risk tolerance is just one factor. You should also consider how long your investments will have to grow. If you’re in a position where you could invest, you should start as soon as you can. Many people invest for their future, and a good retirement calculator can show you why it’s best to invest early and often.