If you undertake any form of financial investing such as stock market investing, it is necessary for you to have a proper appreciation of investment risk. A study published by the Financial Services Authority in the UK called “Consumer Understanding Of Financial Risk” provides some fascinating feedback on how well retail investors understand the investments that they are making. The presence or absence of this understanding has an impact on the way that these investors behave. The study broke down investors into three categories namely the unsophisticated that rely entirely on advisors, the intermediate that have some sophistication and work with their advisors and the sophisticated that tend to manage the affairs independently.

In investing generally, and in stock market investing in particular, it is important to remember that education, even specific business education, does not necessarily translate into expertise when it comes to investing. An investor with a business education may understand the theoretical concepts but could find it difficult to apply his knowledge in practice. Conversely, a retired doctor with plenty of time to study the financial news every day could well be a sophisticated investor when it comes to stock market investing.

The unsophisticated investor when it comes to investing activity such as stock market investing has little or no knowledge and tends to rely excessively on his investment advisers. This over reliance can result in potential abuses of the relationship. On the other hand, if the unsophisticated investor is completely risk averse because of his lack of knowledge, he may not be obtaining the best possible return on his investment.

Very often, because of the lack of clear risk labels on the various forms of investment such as stock market investing, all kinds of misconceptions can arise. For instance, an investor may consider all forms of stock market investing to be highly risky. He may also consider that stock market investing which is entrusted to an advisor or a professional is free of risk. In reality, a high exposure to stocks in the overall investment portfolio presents a higher risk profile than a high exposure to investment-grade income investments. Indeed, no kind of sensible portfolio diversification is possible unless the investor has some knowledge about the various asset classes such as stock market investing and the risk/reward trade off for each one.