Comments on: How Do You Define Risk?

By: Doug

Doug — Fri, 18 Dec 2009 16:59:37 +0000

I have to agree that not meeting your financial goals is a definition of risk. But getting there may be risky, too: losing a job, black swan events, etc. And there is per investment risks: credit risk, reinvestment risk, tax risk, etc. So there really is no encompassing definition of risk except “the action engaged may not turn out the way you expect”.

Know all the sub risks of something (like an investment or goal), try to estimate the probability of each one occurring, then decide whether to proceed, mitigate the risks you can control, or change course.

By: Kyle

Kyle — Thu, 17 Dec 2009 16:28:44 +0000

I buy that variability of returns is probably the best definition of risk we have available (not perfect, just less bad than the others); however, I think the current tools used to measure volatility are inadequate. In order for standard deviation to be meaningful, market returns would have to be normally distributed. Problem is, they aren’t. Market returns are actually a Levy distribution. So current measurements of risk are at best gross oversimplifications of reality, hence things like 2008 happen.

By: Mike

Mike — Wed, 16 Dec 2009 19:03:47 +0000

Neal: I’m on a very similar page there.

Larry: Makes sense to me. I’m in complete agreement that we’d be better off if we used more precise terminology rather than just using the word “risk” to describe a whole myriad of various measurements and phenomena (without even taking the time to mention which one we’re speaking of!).

I think you’re spot-on in that one of the best things investors can do is focus on what they can control rather than what they can’t.

By: Larry

Larry — Wed, 16 Dec 2009 14:37:26 +0000

Maybe I’m not saying anything original or profound (or even correct), but it seems to me that instead of using the loaded word “risk,” one could say there are two, probably uncorrelated ways you can look at the direction of an asset over a given period of time:

1) There are factors that could cause the value of the asset to rise (increase in market value, interest, etc.) or to fall (decrease in market value, taxes, fees, inflation, etc).

2) These factors may be relatively predictable or relatively unpredictable.

So for instance:

If money is put into a Roth IRA, its value could rise or fall depending on the investments chosen. But the tax factor (under current law) is eliminated.

If money in a traditional IRA is deposited into a Vanguard index fund, again its value could rise or fall. But while the tax factor is guaranteed to reduce the value of that money when it is distributed, the loss of value from fees is greatly reduced over putting the same money into a high expense ratio, loaded managed fund.

If money is put into an FDIC-insured CD locked at 2.5% for two years, its nominal value can be predicted to increase by that percentage. But the inflation factor, which is not guaranteed but highly likely, could erode the actual value of those funds over the same time period.

It seems to me that if you analyze the characteristics of each asset or asset class along these lines, you can make the best choices for where to put your money. And you can recognize which of these factors you can control (by reducing fees, diversifying, rebalancing, etc.) and which you can’t (market volatility, inflation, etc.).

By: neal@wealthpilgrim

neal@wealthpilgrim — Tue, 15 Dec 2009 20:15:10 +0000

For me, risk is being unable to achieve my life goals. Anything that gets in my way of doing that, is risky. Sometimes, that means being very conservative is risky.