Portfolio Risk: Meaning, Calculation, and Risk Management

Risk in an investment portfolio means there's a chance that the actual return on your investments will be less than what you expected. It can also mean losing some or all of your original investment, which could impact your financial goals.
Portfolio Risk
3 min

Portfolio risk is the potential for the value of your investments to fluctuate, with chances of a decline or variance in returns.

Managing investment portfolios is a crucial aspect of financial planning, yet it comes with inherent risks that investors must navigate. This article will delve into the concept of portfolio risk, exploring its various types such as market risk, credit risk, and liquidity risk. We will also discuss the best strategies for managing these risks, including diversification, asset allocation, and the use of financial instruments like options and futures. By understanding and effectively managing portfolio risk, investors can safeguard their investments and enhance long-term returns.

What is portfolio risk?

Portfolio risk refers to the chance of your portfolio value decreasing, leading to lesser returns or losses. At times, losses accumulating due to portfolio risk factors can even affect your financial goals. All investments carry some form and degree of potential risks, whether while trading in the stock market, investing in mutual funds, or trading in the forex market. The inherent risk in market investments is why every smart investor knows how to efficiently balance the risks and rewards.

What is the best way to manage portfolio risk?

Every investment portfolio carries risks. The best way to manage portfolio risk is to avoid putting all your money in one instrument. Instead, diversify your investments across assets like bonds, cash, and stocks to minimise risk.

Risk factors are numerous and diverse. However, an understanding of the potential sources of market vulnerability is important as it can help you plan your strategies effectively and ultimately manage your portfolio better.

High-return mutual fund categories for smart investing

Equity Mutual Funds Hybrid Mutual Funds Debt Mutual Funds
Tax Saving Mutual Funds NFO Mutual Funds Multi Cap Mutual Funds


Types of portfolio risk

Following are some of the major factors that can potentially affect your investment returns:

1. Market risk

Market risk includes factors that affect the entire financial market, including the stock market. This includes changes in interest rates, macroeconomic conditions, inflation, recession, and natural disasters. It is also called systemic risk. What’s interesting to note here is that market risk cannot be mitigated by portfolio diversification—the most popular risk mitigation strategy, as it affects the entire financial system.

2. Liquidity risk

Not all investment instruments are equally liquid. While some provide a high degree of liquidity, like mutual fund schemes, others, like real estate or private equity, may be tougher to liquidate and avoid losses if the market moves unfavourably. Liquidity risk may lead to losses as it may necessitate selling off assets at a lower-than-expected price. A good way to mitigate this risk is to have part of your investment portfolio dedicated to liquid assets. For example, you can easily compare mutual funds and invest in a scheme that best aligns with your goals.

3. Credit risk

Credit risk is the chance of incurring a loss as the issuer of the bonds or other financial instruments in your portfolio fails to meet their payment obligations. This includes failure to repay loans and is more commonly associated with corporate bonds. In such cases, a company's trustworthiness becomes a big factor in choosing the right bonds to invest in.

4. Inflation risk

Usually, the prices of goods and services increase with time. If you have Rs. 1,000 in the present, they may not hold the same value 10 years from now. This leads to a decline in the real value of money, affecting long-term investments with fixed rates of returns, like bonds.

5. Reinvestment risk

This refers to the risk associated with having to reinvest your wealth at a lower rate of return compared to the previous tenures.

6. Currency risk

Investors who hold investments in foreign currencies are vulnerable to risks arising from movements in currency exchange rates. A change in the price of one currency (appreciation or depreciation) may pose a portfolio risk depending on the type of investment.

7. Concentration risk

This type of risk arises with homogeneous or similar investments and can be managed effectively through portfolio diversification.

8. Political risk

Political or economic instability and changes in government regulations or policies can have a significant impact on your portfolio as well.

Also read about: What is a risk profile

How to calculate portfolio at risk?

After learning the various types of portfolio risks, let us understand how to calculate portfolio risk using the methods described below.

1. Standard Deviation

Taking a mean value of returns in your portfolio, we can calculate the standard deviation to understand how returns would be dispersed. The formula for standard deviation is-

2. Value at Risk (VaR)

Value at risk is a statistical technique that can be used to measure the potential financial losses in your portfolio over a given period. It is calculated by factoring in your portfolio's standard deviation, the rate of return, the individual rates of return, and the proportion of each investment in the portfolio.

3. Conditional Value at Risk (CVaR)

This method calculates the expected losses in your portfolio exceeding a specified threshold. It can be viewed as an extension of VaR by representing the anticipated shortfall beyond this limit.

4. Sharpe Ratio

Sharpe Ratio is a popular method for understanding ROI in relation to the associated risk. Its formula is:

5. Sortino Ratio

It is similar to the Sharpe ratio, with the difference being that this only takes into consideration the standard deviation of a portfolio’s downside risk instead of the overall standard deviation. It can be calculated with the following formula:

6. Strategies to manage portfolio risk

Portfolio risk management can help you identify potential risks and vulnerabilities in your portfolio that impact your financial goals. Let us take a look at its major aspects.

7. Identification

This includes identification, documentation, and understanding of potential risk factors.

8. Assessment and measurement

This aspect includes assessing the potential impact of risk factors and relying on quantitative analysis to measure their likely impact on your portfolio.

9. Mitigation and strategy

In this stage, investors devise strategies to mitigate risks, which include budgeting, diversification, and hedging.

10. Monitor and review

Risk management is not a one-time practice but requires constant monitoring and review of the market conditions and risk factors.

Tools to assess and manage risk in portfolio

The most common techniques for risk management include:

1. Hedging to limit exposure

Using financial instruments to offset potential losses by taking opposite positions in related assets.

2. Active management based on market conditions

Continuously adjusting the portfolio in response to market changes to capitalise on trends and reduce volatility risks.

3. Risk budgeting to align with your risk tolerance

Allocating specific portions of the portfolio to different risk levels to match your risk tolerance and goals.


Portfolio risk refers to potential value fluctuations, leading to reduced returns or losses. Primary types of portfolio risk include market, liquidity, credit, inflation, reinvestment, currency, concentration, and political risks. It can be calculated using methods like standard deviation, VaR, CVaR, Sharpe Ratio, and Sortino Ratio. Effective risk management requires identifying, assessing, mitigating, and monitoring risks through techniques like hedging, active management, and risk budgeting, helping investors navigate uncertainties and protect their portfolios.

If you wish to invest in mutual funds, you can head to the Bajaj Finserv Mutual Fund Platform and select from over 1,000 mutual fund schemes. You can also rely on the lumpsum calculator and SIP calculator to calculate potential returns and choose MF schemes that align with your investment goals.

Essential tools for mutual fund investors

Mutual Fund Calculator Lumpsum Calculator SIP Calculator Step Up SIP Calculator
SBI SIP Calculator HDFC SIP Calculator Nippon India SIP Calculator ABSL SIP Calculator
Tata SIP Calculator BOI SIP Calculator Motilal Oswal Mutual Fund SIP Calculator Kotak Bank SIP Calculator

Frequently asked questions

What is a portfolio risk example?
Portfolio risk examples include changes in interest rates, inflation, recession, and political turmoil, as they directly impact the markets. This can cause your investments to fall in value and put your portfolio at risk.
What is portfolio risk, and how is it measured?
Portfolio risk is the looming possibility of a decline in the value of your investment portfolio due to several factors in the stock market, such as inflation and interest rate changes. Popular methods to measure portfolio risk include standard deviation and Sharpe ratio.
What are the three types of portfolio management?
The three types of portfolio management include active, passive, and discretionary portfolio management. In active portfolio management, an investor buys and sells securities for risk management, while in the passive method, the investor buys a security for the long term. In the discretionary method, a third party is hired to manage trading and mitigate risks.
What is portfolio risk with an example?
The potential for loss in your investment portfolio is known as portfolio risk. It also includes the fall in value of your portfolio. This can occur due to various factors like changes in the currency market and interest rate fluctuations.

For instance, if the economy sees high inflation rates, the prices of securities in your portfolio can change, resulting in losses.

What is the portfolio at risk ratio?
The portfolio risk ratio is derived by calculating the ratio of the total balance of loans over 30 days past due, along with all refinanced (restructured) loans, to the outstanding gross portfolio value on a specific date.
What is the importance of portfolio at risk?
Portfolio risk is important to understand the interplay of market factors and how they may affect your investments. Only by effectively managing portfolio risk will you be able to protect and grow your wealth, even during market fluctuations, and achieve your long-term financial goals.

Why portfolio can reduce risk?
Diversifying your portfolio is an effective way to reduce risk. Investing in several different types of assets ensures that the positive movements in one will offset the negative movements in another, ensuring stable returns with minimal risk in the long run.

What happens to portfolio risk?
Portfolio risk is the likelihood of a reduction in the value of your investments. Effectively managing portfolio risk is necessary for stable growth. If left unmanaged, it can adversely impact your investment and capital and lead to significant losses.

Show More Show Less

Bajaj Finserv App for All Your Financial Needs and Goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Explore and apply for co-branded credit cards online.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on No Cost EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more


Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.