Risk is all around us. Some people consider driving a car risky. Others don't seem to mind driving but are terrified of flying in an airplane--even though statistics show you're far more likely to die in a car than in an airplane. Some people, like race car drivers, cliff divers, and bungee jumpers, actually thrive on risk; others go to great lengths to reduce or avoid it.

Risk is multidimensional with many factors interacting. For example, an athlete in top physical condition may suffer a fatal heart attack while exercising because he or she has a family history of heart disease. Some risks are more apparent than others. For instance, walking a high wire is quite obviously a risk. On the other hand, the danger of being struck by lightning is not so obvious.

Nobody can fully escape risk. The best you can do is to reduce (or "hedge") as much as possible. Stay clear of people with colds, maintain a healthy diet; wear a life jacket when boating. Most importantly, purchase adequate health, property, and liability insurance.

Risk in the Investment World
Some people view risk as a negative, others as a positive. Ask any group of people what risk means to them, and you are likely to get some of these answers:

• Danger
• Possible loss
• Uncertainty
• Challenge
• Opportunity
• Thrill

In the investment world, however, risk equals uncertainty. It refers to the possibility of losing an investment or that an investment will yield less than its anticipated return. Quite simply, investment risk refers to the probability that an investment will make or lose money. Every investment carries some degree of risk because its returns are unpredictable. The degree of risk associated with a particular investment is known as its volatility.

The Relationship Between Risk and Return
When you invest, you plan to make money on that investment or, more accurately, earn a return. Risk and return are directly related. The higher the risk, the higher the return potential. If you want a higher rate of return, you will have to accept a higher risk. Conversely, you may accept a lower risk, but the return potential is lower.

Technical Note: The term "risk-return trade-off" refers to the universal principle that investors should plan to be compensated for taking higher levels of risk of loss by earning higher rates of return.

The Relationship Between Risk and Time
The length of time that you plan to remain in a particular investment vehicle is known as your time horizon. Generally speaking, the longer your time horizon, the more you can afford to invest more aggressively, in higher-risk investments. This is because the longer you can remain invested, the more time you'll have to ride out fluctuations in the hope of getting a greater reward in the future. Of course, there is no assurance that any investment will not lose money.
Risk-taking propensity

Each of us is able to accept a certain amount of investment risk. This is known as our risk-taking propensity. Those of us who can accept a relatively great amount of risk are referred to as risk tolerant. On the other end of the spectrum, those who can accept very little risk are known as risk averse. Those who hold the middle ground are risk neutral or risk indifferent.

There are ways to measure your risk tolerance, using tests to assess how you react to different types of risk, such as monetary, physical, social, and ethical. These tests aren't foolproof, since we are essentially talking about psychological behaviors that may vary under different conditions. However, the results from these tests are generally considered reliable and valid.

Your risk-taking propensity is as important in determining which investments match your risk-return expectations as the risk of the investment itself.

Diversify Your Portfolio to Reduce Risk
One of the best ways to reduce risk is to develop a portfolio of investments that is balanced in terms of the types of assets in which you invest. In other words, don't put all your eggs in one basket. This is known as diversification or asset allocation. A portfolio that mixes a variety of asset classes (e.g., cash, bonds, domestic and foreign stocks, and real estate) has a lower risk for a given level of return than does a portfolio that consists of only one. Diversification works because it broadens your investment base. It can be achieved by company, industry, type of security, markets, or by investment objective.

How an investor diversifies depends upon his or her own situation. An investor can be aggressive (investing mostly in high-risk vehicles), conservative (investing mostly in low-risk vehicles), or somewhere in between.

Diversify with the Passage of Time
Historically, time has had a dampening effect on the riskiness of investments. Basically, the longer an investor remains invested--or the longer the investor's time horizon--the less risky the investment becomes. Of course, there is no guarantee this will continue in the future.

Do Your Homework
You may be able to reduce some risk simply by being diligent. For example, have real estate inspected and appraised before you buy it, or investigate a company's financial condition before you purchase stock in it.

Gauge the economy by identifying trends in overall business conditions. These trends are indicated regularly (weekly or monthly) by figures on inventories, prices, employment, and the GDP. Is the economy on an upswing or downswing? Knowing this will help you choose an investment more likely to appreciate under the given conditions.

Choose investments that make sense to you. For example, buy stock in a company with relatively stable earnings, or one whose sales are likely to keep up with inflation, or one whose products are in great demand, or one who sells a product for which the demand is constant, such as food