Final answer:
Total risk is composed of systematic and unsystematic risk. Unsystematic risk can be reduced through diversification, whereas systematic risk is inherent to the market. Investment risk level is often higher earlier in an investor's career and becomes more conservative as they near retirement.
Step-by-step explanation:
Total Risk Components and Diversification
The total risk associated with financial assets is comprised of two main components: systematic risk and unsystematic risk. Systematic risk, also known as market risk, is inherent to the entire market or market segment. This type of risk is influenced by factors such as economic, political, or natural events that affect all market participants and cannot be eliminated through diversification. Unsystematic risk, on the other hand, is specific to a particular company or industry. This type of risk can be reduced, or even eliminated, through diversification of an investment portfolio.
Diversifying a portfolio involves investing in a variety of assets such that the performance of any single investment has less impact on the overall portfolio. This reduces the unsystematic risk and contributes to a potentially more stable return on investment. It is important for investors to diversify because it helps to manage the risk-reward balance and protects against losses in any one particular area. However, no amount of diversification can completely eliminate the systematic risk.
As for the risk level throughout an investor's life, it is often recommended that younger investors, being in the early part of their career, can afford to take on higher levels of risk because they have more time to recover from any potential losses. As investors approach retirement, they generally shift toward more conservative investments to preserve capital and ensure a stable income during retirement.
Financial Assets and Risk
Financial assets such as bonds, stocks, and mutual funds each bear different levels of risk and potential return. Bonds are typically considered safer but with lower returns, while stocks are seen as riskier with potential for higher returns. Mutual funds offer a balance through a diversified pool of investments. Finding the safest investment becomes a matter of personal risk tolerance and investment goals.