The phrase “inherent risk” basically translates to, “FYI, there might be something wrong here.” It doesn’t mean there is something wrong, but it means there might be. And when we say “wrong,” we don’t necessarily mean that someone did something intentionally bad...we might just mean that there are possible mistakes in our information, or that we’re making decisions based on things we aren’t certain about.
Two quick examples:
On the one hand, as mentioned, “inherent risk” might refer to the probability that mistakes were made calculating and/or reporting complex business transactions. There are a ton of regulations in certain industries, especially those related to finance, and there’s always a chance that a small step or piece of the puzzle was overlooked when a company’s information was compiled or reported. When those businesses or business processes are audited, it’s the auditor’s responsibility to specifically look for and assess inherent risk, and possibly offer solutions to reduce its likelihood or mitigate its effects.
On the other hand, “inherent risk” can simply mean that we’re making predictions based on things that are...unknowable. If our traveling circus company is about to expand operations into a new country, we can release all sorts of studies and estimates and financial statements showing how awesome and profitable this venture might be, but we can’t know 100% how it’s going to turn out until we do it. In other words, our venture has some inherent risk: things might happen that cause financial loss, but we don’t know for sure what those things might be, or how much financial loss they might entail.
Related or Semi-related Video
Finance: What is market risk?5 Views
Finance Allah shmoop what is market risk All right There
are a lot of risks when you invest money Two
of the most common categories are unsystematic risk And yes
of course systematic risk Also known as market risk Well
unsystematic risk refers to risks linked to a specific stock
or security So you buy shares in your dad's publicly
traded ice cream company and the company goes bankrupt Who
knew pork rind ice cream would prove so unpopular Who
knew well that's unsystematic risk You made a bad investment
and you paid for it by losing everything you invested
un systematically Well that's individual stock risk or in systematic
risk AII bad brain bad return What not all investments
do well In fact many of them do poorly even
for the best of investors So most professionals diversify their
eggs such that not all of them are invested in
one stock or one basket So that revolves around unsystematic
risk That is risk You can actually do something about
and improve your odds of being successful like by being
a good smart investor But then there's market risk which
just exists as a natural part of the risk world
For illustrative purposes You could choose to not take any
road risk Like when you drive on the roads Your
odds of being hit by some idiot texting his girlfriend
and not looking at the double yellow line are not
one in a good Gillian right You also have a
risk of a tire blowout or a tree falling on
you or skidding into a mailbox on that hill with
the gravel in the oil slick from the construction people
right Those are all quote market risks unquote of driving
So why do it Why drive Why not just stay
home Never leave the house get Amazon and door dash
and ups to take care of all of your needs
and never suffer the market risk of dying on the
road Well for some people this probably is a good
idea Well the same allegory lives in the stock market
When you invest in stocks odds are extremely high that
at some period while their value will go down maybe
a lot You can't head yourself against things like terrorist
attacks and natural disasters political upheaval and zombie apocalypses or
apocalypse side They say The zombie There's no real way
to protect yourself against market risk It's just systematic It's
part of the system Got it So there's no way
to deal with market risk other than for one thing
time Historically the stock market goes up over time Check
out this glorious chart running for one hundred years in
change for what the market is done without even calculating
the additional return from dividends distributed along the way Well
you can see that there has rarely been an extended
period of time when the market didn't go up and
or at least distribute enough in dividends Such that in
each decade while there's been a nicely positive return from
being invested in the stock market could this suddenly change
and go the other direction such that we have half
a century of no growth Sure but that would be
a big departure from the way our driving has gone
in the past on the roads But you never know
There's always the N plus one idiot out there texting
and driving and you know really not giving a
Up Next
How are risk and reward related? Take more risk, expect more reward. A lottery ticket might be worth a billion dollars, but if the odds are one in...