What is risk of ruin?
The probability of an investor losing all his or her investment capital without the chance of recovery. It's calculated using the probability of making a return on investment (ROI) with that of making a loss and the proportion of an investor's capital that's at stake.
Where have you heard about risk of ruin?
It's a relatively well known and self-explanatory concept. Anyone who has played Monopoly knows it. As the game moves on, the board fills with houses and hotels, increasing the risk of in-game financial ruin.
What you need to know about risk of ruin.
Risk of ruin often results in bankruptcy, though not necessarily. It's more intended as a signpost marking the "point of no return" for traders and investors.
There are two main strategies for reducing the risk of ruin:
- Diversification - where an investor tries to own a wide range of assets, e.g. bonds, property, shares and liquid assets
- Hedging - constructed from any number of financial instruments
It's also a term sometimes used by financial traders for when a trading account balance drops below the minimum requirements to continue trading.
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