Risk of ruin
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.