Comments on: Redefining Risk: Your Investments Aren’t as Risky as You Think

By: Adfecto

Adfecto — Fri, 15 Feb 2008 21:47:11 +0000

Great post. I think you are completely right. I actually see no risk in investing, why? With each paycheck money is whisked away to “investing land” where it becomes nothing but a number. My investing is like a game to see how big I can get that number before I quit working. My life is great without the money, I don’t miss it. If my investment decline it does not affect me at all, I just try harder to win the game (aka save more and maintain my asset allocation). If I never had the money to begin with how can I miss it? How is it risky if it is money I don’t need (at least until retirement decades away).

By: 99kby2011

99kby2011 — Thu, 14 Feb 2008 02:36:33 +0000

Very much enjoyed this post – a refreshing way to look at the importance of investing. You often hear about the other side of “risk” and this is just as (more?) important a point of view. Thanks!

By: Jeremy

Jeremy — Wed, 13 Feb 2008 17:24:20 +0000

You’re right, that wasn’t the best analogy I used. Selling for a loss on an investment purchased with the intent of appreciating over 20 or 30 years is simply realizing a loss. If the investment is volatile by nature, selling early may simply force you to realize a loss based on being afraid of volatility in terms of risk, when it in fact may simply be the nature of the beast.

But hey, this is why there are comments on a site like this. Everyone can benefit from the different viewpoints and expansion on topics.

By: Fiscal Musings

Fiscal Musings — Wed, 13 Feb 2008 17:08:02 +0000

Jeremy, I’m not disagreeing with what you’re saying here. My original disagreement was with the statement, “you only take a risk when you sell for a loss”. That is realizing a position, not assuming risk. That’s all.

I understand fully and agree with you that the “risk” is very low for a 30 year old with a long time horizon who invests in well diversified things. These are risk mitigation efforts because their is still a chance for loss, albeit an off one.

I do appreciate the opportunity for the discussion though. Many would just fly off the handle the moment someone shows a counter viewpoint.

By: Jeremy

Jeremy — Wed, 13 Feb 2008 14:50:33 +0000

Fiscal Musings, no, I agree with you that the words aren’t interchangeable, and that is the underlying point I was trying to make with this post. It is just that when someone says they are risk adverse, or don’t want to have risky investments, what they are really worried about is volatility. Meaning, they don’t want to see their account values go down, or at least not down significantly.

So, going back to Investopedia’s definition: “The chance that an investment’s actual return will be different than expected.”

This is where it all comes down to what is expected. If a 30 year old has a 100% stock portfolio that is designed to be for retirement savings 30+ years from now, with the way the word risk is thrown around, this appears to be a risky portfolio. Does 100% stock have a high standard deviation? Yes, but that really just measures volatility, not overall risk.

History has shown that stocks typically return between 9-11% annually. So if this 30 year old investing in stocks for the next 30 years, what is his EXPECTED result? He probably expects that 30 years from now that he will have realized close to that return, and if history is any indication, that is far more likely than unlikely, thus low risk.

If you just think of risk as standard deviation, you could argue that an FDIC insured savings account carries no risk, but that is false. While the risk of losing your principal is 0, you are faced with interest rate risk, inflation risk, and the risk of outliving your money.

Which brings me to the original point of this post, is that if a person like this is trying to save for 30 years for retirement in an account that has no apparent risk (i.e. their account value can’t fluctuate or go down in value), they will be taking on far more risk that after inflation, taxes, and the length of their life that they will be unlikely to fulfill their goals or have enough money to sustain their full retirement.

By: Ron@TheWisdomJournal

Ron@TheWisdomJournal — Wed, 13 Feb 2008 14:10:55 +0000

Thank you thank you thank you.
I’ve been saying this for years.
I wish I could have shown this post to my Corporate Finance professor in graduate school.

By: Fiscal Musings

Fiscal Musings — Wed, 13 Feb 2008 05:26:59 +0000

I can see what you’re getting at, but it doesn’t make any sense to “realize a risk”. When you sell at a loss, you’ve realized a loss, and it ceases to be any sort of risk because there’s nothing uncertain and no chance involved anymore.

And when you talk about long time horizons and diversified funds, you have to call these tactics what they are: ways to reduce or hedge the risk of investing in the market. If risk and volatility were interchangeable, we wouldn’t have the distinction of the two terms.

By: Jeremy

Jeremy — Wed, 13 Feb 2008 01:03:50 +0000

Well nothing completely eliminates risk, but when you sell a position for a loss, you have cemented your loss, or otherwise realized the very risk that you were afraid of. Just like a stock or investment can go down in value, it can also go back up in value. So if you sell, you "realize" the risk, when in fact, for all you know, the investment could return to or increase in value, making that supposed risk non-existent.

And again, this type of discussion is for someone who has a non-diversified portfolio and is invested in a single company, or a single sector like airlines. In almost any real world scenario, the collection of funds and investments someone holds makes up hundreds, if not thousands of companies. This makes the typical definition of risk almost worthless if you are talking about a time frame of decades.

For most investors who invest in index or mutual funds, ETFs, or other diversified methods, even a 100% stock portfolio wouldn't be very risky. Volatile from day to day and year to year? Sure, but if you just owned an S&P 500 fund for 25 years, what is the probability of losing money over that time frame? I'd have to say it would be pretty close to 0.

So my only argument with this is to highlight the fact that when most people are talking about risk, they are really concerned with volatility. And by making unwise investment decisions by trying to minimize a risk that isn't as real as it seems, they are putting more important long-term risks in danger.

By: Fiscal Musings

Fiscal Musings — Wed, 13 Feb 2008 00:43:31 +0000

Unfortunately, I must disagree with you. “You only take a risk when you sell for a loss”…? The meaning of the word risk presupposes an undetermined outcome. If you sell for a loss, you know what the outcome is and therefore are actually under less risk because the investment can’t go down any further.

While the tactic you mention of not selling may be one way to reduce or hedge your risk, it does not get rid of your risk. Just look at the auto or airline industry (many billion dollar companies).

I would look at how Investopedia defines risk:

The chance that an investment’s actual return will be different than expected. This includes the possibility of losing some or all of the original investment. Risk is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.

By: Jeremy

Jeremy — Tue, 12 Feb 2008 20:50:12 +0000

That’s exactly right, and that is the risk of outliving your money. If you just tuck it away in a savings account, CDs, or other investments that can barely keep up with inflation, you’ll find that in 20 years and paying taxes on the money, you’ve actually lost money.

Sure, most people think that because the dollar amount is bigger than what they started with that they made out pretty well, but all they’ve done is waste their working years only to find out they won’t be able to afford any of the things they had planned for the non-working years.