Risk averse savers seek to minimize the variability in the return on their savings and prefer security in their investments. Risk loving savers prefer to gamble by holding a risky investment with the possibility of maximizing returns. Three types of risk you face in investing are market risk , idiosyncratic risk, and inflation risk. Market risk is general fluctuations in the economy that can increase or decrease returns on stocks. Idiosyncratic risk is the price of an individual stock may be influenced by factors such as discoveries, strikes, or lawsuits that influence the profitability of the firm and its share value.
Inflation risk is the erosion in the purchasing power of the money invested due to rising prices.
Any level of inflation above zero means that a future dollar is worth less than a present one. Therefore, an important investment goal is to earn a rate of return that excees inflation, at a very minimum. Market risk cannot be avoided, but idiosycratic risk can be avoided through diversification because if you own 30 stocks not everyone of them will suffer from strikes, lawsuits, or new discoveries that make their product obsolete. Diversification allows you to reduce overall risk by averaging the risk of each asset in the portfolio and maintain the rate of return at the same level of risk. On the other hand in owning a few stocks there is a greater probability for a loss and a higher degree of risk.