Target Risk
Target risk is the desired level of risk associated with an investment or portfolio. It is typically expressed in terms of the potential return and volatility of an investment.
Factors Affecting Target Risk:
- Investor’s risk tolerance: Investors’ risk tolerance determines their willingness to accept different levels of potential return and volatility.
- Investment goals: Investors’ goals and time horizon influence their target risk.
- Economic conditions: Economic factors, such as interest rates and inflation, can affect target risk.
- Market conditions: Market volatility and expected returns can impact target risk.
- Investment strategy: The investment strategy used dictates the target risk level.
Setting Target Risk:
- Assess risk tolerance: Determine your willingness to accept potential losses.
- Consider investment goals: Consider your time horizon and financial goals.
- Analyze economic factors: Consider interest rates and inflation.
- Consider market conditions: Evaluate market volatility and expected returns.
- Select an investment strategy: Choose an investment strategy that aligns with your risk tolerance and goals.
Example:
An investor with a high risk tolerance and a long time horizon might have a target risk of 10-15%. This indicates that they are comfortable with the potential for high returns but also accept a higher level of volatility.
Target Risk Examples:
- Low-risk portfolio: Target risk of 3-5%, suitable for retirees or conservative investors.
- Moderate-risk portfolio: Target risk of 6-8%, appropriate for investors with a moderate risk tolerance and a medium-term time horizon.
- High-risk portfolio: Target risk of 9-12%, suitable for aggressive investors with a long time horizon and a high risk tolerance.
Note:
Target risk is not a static value and can fluctuate over time as market conditions and personal circumstances change. It is important to regularly review and adjust your target risk as needed.
FAQs
What is a target risk?
Target risk refers to the desired or acceptable level of risk that an organization aims to achieve after implementing risk controls or mitigation strategies. It represents the level of risk that is deemed manageable and aligns with the companyโs risk appetite.
What is the difference between target risk and inherent risk?
Inherent risk is the level of risk that exists before any controls or mitigation strategies are applied. Target risk, on the other hand, is the level of risk an organization aims for after applying risk management strategies to reduce the inherent risk.
What is residual risk?
Residual risk is the level of risk that remains after all risk mitigation measures have been applied. It is the risk that an organization still faces even after taking steps to reduce inherent risk.
What is the difference between target risk and residual risk?
Target risk is the ideal level of risk an organization aims to reach, while residual risk is the actual risk that remains after mitigation efforts. In some cases, the residual risk may exceed or fall short of the target risk.
What are the 3 C’s of risk?
The 3 C’s of risk are Capacity (ability to absorb risk), Capital (financial resources to withstand risks), and Collateral (assets used as security against risk).
