Uncompensated risk

In investments, uncompensated risk is the level of additional risk for which no additional returns are generated and when taking systematic withdrawals make the probability of failure unacceptably high.

Thus, looking solely at the US Market, investing in the Total Stock Market would present you with compensated risk since you own a representative weighted average of the entire market. You are "compensated" for taking on risk in your portfolio by higher expected returns. When you invest in stocks, you have higher risk than with bonds. But you expect a higher return.

Conversely, if you owned only an individual stock or only a single market sector you would have significant uncompensated risk. By investing in one stock or one single market sector, you are not compensated for that extra risk (since that risk can be diversified away by owning the Total Stock Market). You should expect to get the same return as the market, but you have a lot more risk in your portfolio.

The efficient market hypothesis states that you are not rewarded for taking uncompensated risk.



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