There are lots of different kinds of investment risk, including inflation risk, credit risk and interest-rate risk. However, what I term modern prudent fiduciary investing--that is, the Restatement (Third) of Trusts and the Uniform Prudent Investor Act--is grounded in Modern Portfolio Theory. As a result, it’s concerned primarily with the nature of portfolio risk and how to diversify it prudently. So let’s see what that means.
The total risk carried by a portfolio of stocks--or a single stock or mutual fund, or fixed income investments, for that matter--can be separated into two kinds: uncompensated risk, which comprises about 70% of total portfolio risk, and compensated risk, which comprises about 30%.
W. Scott Simon does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.