Risk is Manageable: Risk-Avoidance Strategies

Master Investors use one of the four-risk avoidance strategies:
1.  Don't invest.
2.  Reduce risk (the key to Warren Buffett's approach).
3.  Actively manage risk (the strategy George Soros uses so astonishingly well).
4.  Manage risk actuarially.

There is a fifth risk-avoidance that is highly recommended by the majority of investment advisors:  diversification.  But to Master Investors, diversification is for the birds.

No successful investor restricts himself to just one of these four risk-avoidance strategies.  Some - like Soros - use them all.

Corporate Finance - Types of Risk

Like anything, projects do have risks. There are three types of project risks associated with capital budgeting:
1. Stand-alone risk
2. Corporate risk
3. Market risk

1.Stand-Alone Risk This risk assumes the project a company intends to pursue is a single asset that is separate from the company's other assets. It is measured by the variability of the single project alone. Stand-alone risk does not take into account how the risk of a single asset will affect the overall corporate risk.

2.Corporate RiskThis risk assumes the project a company intends to pursue is not a single asset but incorporated with a company's other assets. As such, the risk of a project could be diversified away by the company's other assets. It is measured by the potential impact a project may have on the company's earnings.
3.Market RiskThis looks at the risk of a project through the eyes of the stockholder. It looks at the project not only from a company's perspective, but from the stockholder's overall portfolio. It is measured by the effect the project may have on the company's beta.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/types-of-risk.asp#ixzz1yhCYuBuY

Risk-Return Tradeoff

Definition of 'Risk-Return Tradeoff'

The principle that potential return rises with an increase in risk. 

• Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. 
• According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost. 

Investopedia explains 'Risk-Return Tradeoff'

Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. 

• Taking on some risk is the price of achieving returns; therefore, if you want to make money, you can't cut out all risk. 
• The goal instead is to find an appropriate balance - one that generates some profit, but still allows you to sleep at night.

Read more: http://www.investopedia.com/terms/r/riskreturntradeoff.asp#ixzz1yNTT4zyp

The 3 Types of Investment Risk

The 3 Types of Investment Risk
The Basics of Risk Management 
 By Joshua Kennon, About.com Guide

Smart investing includes risk management. For each stock, bond, mutual fund or other investment you purchase, there are three distinct risks you must guard against; they are business risk, valuation risk, and force of sale risk. In this article, we are going to examine each type and discover ways you can protect yourself from financial disaster.

Investment Risk #1: Business Risk

Business risk is, perhaps, the most familiar and easily understood. It is the potential for loss of value through competition, mismanagement, and financial insolvency. There are a number of industries that are predisposed to higher levels of business risk (think airlines, railroads, steel, etc).

The biggest defense against business risk is the presence of franchise value. Companies that possess franchise value are able to raise prices to adjust for increased labor, taxes or material costs. The stocks and bonds of commodity-type businessesdo not have this luxury and normally decline significantly when the economic environment turns south.

Investment Risk #2: Valuation Risk

Recently, I found a company I absolutely love (said company will remain nameless). The margins are excellent, growth is stellar, there is little or no debt on the balance sheet and the brand is expanding into a number of new markets. However, the business is trading at a price that is so far in excess of it's current and average earnings, I cannot possibly justify purchasing the stock.

Why? I'm not concerned about business risk. Instead, I am concerned about valuation risk. In order to justify the purchase of the stock at this sky-high price, I have to be absolutely certain that the future growth prospects will increase my earnings yield to a more attractive level than all of the other investments at my disposal.

The danger of investing in companies that appear overvalued is that there is normally little room for error. The business may indeed be wonderful, but if it experiences a significant sales decline in one quarter or does not open new locations as rapidly as it originally projected, the stock will decline significantly. This is a throw-back to our basic principle that an investor should never ask "Is company ABC a good investment"; instead, he should ask, "Is company ABC a good investment at this price."

Investment Risk #3: Force of Sale Risk

You've done everything right and found an excellent company that is selling far below what it is really worth, buying a good number of shares. It's January, and you plan on using the stock to pay your April tax bill.

By putting yourself in this position, you have bet onwhen your stock is going to appreciate. This is a financially fatal mistake. In the stock market, you can be relatively certain of what will happen, but not when. You have turned your basic advantage (the luxury of holding permanently and ignoring market quotations), into a disadvantage.

Consider the following: If you had purchased shares of great companies such as Coca-Cola, Berkshire Hathaway, Gillette and Washington Post at a decent price in 1987 yet had to sell the stock sometime later in the year, you would have been devastated by the crash that occurred in October. Your investment analysis may have been absolutely correct but because you imposed a time limit, you opened yourself up to a tremendous amount of risk.

Being forced to sell your investments is really something known as liquidity risk, which is important enough I wrote a separate article about it to help you understand why it poses such a threat to your net worth.

The Moral

There is always some degree present in every investment you purchase. At the same time, by avoiding or minimizing specific types of risk, you can keep temporary hiccups in the economy or financial markets from destroying your wealth.


http://beginnersinvest.about.com/cs/valueinvesting1/a/080103a.htm

Every Choice Comes with Risk

by Michele Cagan, CPA

In the investment world, you'll have to walk a delicate (and very personal) balance between risk and reward. The more uncertain the investment, the greater the risk that your investment won't perform as expected, or even that you'll lose your entire investment. Along with greater investment risk, though, comes an opportunity to earn greater investment returns. If you're uncomfortable with too much risk and seek to minimize it, your trade-off will be lower investment returns (which can be a form of risk in itself). Truthfully, you can't completely eliminate risk. If you don't take any risk at all, you won't be able to earn money through investing.

Investment risk is directly tied to market volatility — the fluctuations in the financial markets that happen constantly over time. The sources of this volatility are many: interest-rate changes, inflation, political consequences, and economic trends can all create combustible market conditions with the power to change a portfolio's performance results in a hurry. Ironically, this volatility, by its very nature, creates the opportunities for economic benefit in our own portfolios, and that is how risk impacts your investments and your investment strategy.

There are many different types of risk, and some are more complicated than others. The 7 risk classifications you'll learn about here are those you'll likely take into consideration as you begin to design your portfolio.

Stock Specific Risk

Any single stock carries a specific amount of risk for the investor. You can minimize this risk by making sure your portfolio is diversified. An investor dabbling in one or two stocks can see his investment wiped out; although it is still possible, the chances of that happening in a well-diversified portfolio are much more slender. (One example would be the event of an overall bear market, as was seen in the early 1990s.) By adding a component of trend analysis to your decision-making process and by keeping an eye on the big picture (global economics and politics, for example), you are better equipped to prevent the kinds of devastating losses that come with an unexpected sharp turn in the markets.

Risk of Passivity and Inflation Rate Risk

People who don't trust the financial markets and who feel more comfortable sticking their money in a bank savings account could end up with less than they expect; that's the heart of passivity risk, losing out on substantial earnings because you did nothing with your money. Since the interest rates on savings accounts cannot keep up with the rate of inflation, they decrease the purchasing power of your investment over time — even if they meet your core investing principle of avoiding risk. For this somewhat paradoxical reason, savings accounts may not always be your safest choice. You may want to consider investments with at least slightly higher returns (like inflation-indexed U.S. Treasury bonds) to help you combat inflation without giving up your sense of security.

A close relative of passivity risk, inflation risk is based upon the expectation of lower purchasing power of each dollar down the road. Typically, stocks are the best investment when you're interested in outpacing inflation, and money-market funds are the least effective in combating inflation.

Market Risk

Market risk is pretty much what it sounds like. Every time you invest money in the financial markets, even via a conservative money-market mutual fund, you're subjecting your money to the risk that the markets will decline or even crash. With market risk, uncertainty due to changes in the overall stock market is caused by global, political, social, or economic events and even by the mood of the investing public. Perhaps the biggest investment risk of all, though, is not subjecting your money to market risk. If you don't put your money to work in the stock market, you won't be able to benefit from the stock market's growth over the years.

Credit Risk

Usually associated with bond investments, credit risk is the possibility that a company, agency, or municipality might not be able to make interest or principal payments on its notes or bonds. The greatest risk of default usually lies with corporate debt: Companies go out of business all the time. On the flip side, there's virtually no credit risk associated with U.S. Treasury-related securities, because they're backed by the full faith and credit of the U.S. government. To measure the financial health of bonds, credit rating agencies like Moody's and Standard & Poor's assign them investment grades. Bonds with an A rating are considered solid, while C-rated bonds are considered unstable.

Currency Risk

Although most commonly considered in international or emerging-market investing, currency risk can occur in any market at any time. This risk comes about due to currency fluctuations affecting the value of foreign investments or profits, or the holdings of U.S. companies with interests overseas. Currency risk necessarily increases in times of geopolitical instability, like those caused by the global threat of terrorism or war.

Interest Rate Risk

When bond interest rates rise, the price of the bonds falls (and vice versa). Fluctuating interest rates have a significant impact on stocks and bonds. Typically, the longer the maturity of the bond, the larger the impact of interest rate risk. But long-term bonds normally pay out higher yields to compensate for the greater risk.

Economic Risk

When the economy slows, corporate profits — and thus stocks — could be hurt. For example, political instability in the Middle East makes investing there a dicey deal at best. This is true even though much of the region is flush with oil, arguably the commodity in greatest demand all over the planet.

http://www.netplaces.com/investing/designing-your-personal-portfolio/every-choice-comes-with-risk.htm

What is Risk?

Risk  is incorporated  into  so many  different disciplines from insurance to
engineering  to  portfolio  theory  that it should  come as no surprise that it is defined  in
different ways by each one. It is worth looking at some of the distinctions:

a. Risk versus Probability: While some definitions of risk focus only on the probability
of an  event occurring, more comprehensive definitions incorporate both  the
probability  of the event occurring and  the consequences of the event. Thus, the
probability  of a severe earthquake may  be very small but the consequences are so
catastrophic that it would be categorized as a high-risk event.

b. Risk versus Threat: In some disciplines, a contrast is drawn between risk and a threat.
A threat is a low probability  event with very  large negative consequences, where
analysts may be unable to assess the probability. A risk, on the other hand, is defined
to  be a higher probability  event, where there is enough  information  to  make
assessments of both the probability and the consequences.

c. All outcomes versus Negative outcomes: Some definitions of risk tend to focus only
on  the downside scenarios, whereas others are more expansive and  consider all
variability as risk. The engineering definition of risk is defined as the product of the                                               

probability of an event occurring, that is viewed as undesirable, and an assessment of
the expected harm from the event occurring.

Risk = Probability of an accident * Consequence in lost money/deaths

In contrast, risk in finance is defined in terms of variability of actual returns on an
investment around  an  expected return, even  when  those returns represent positive
outcomes.



Risk and Reward
The “no free lunch” mantra has a logical extension. Those who desire large
rewards have to be willing to expose themselves to considerable risk. The link between
risk and return is most visible when making investment choices; stocks are riskier than 
bonds, but generate higher returns over long  periods. It is less visible but just as
important when making career choices; a job in sales and trading at an investment bank

may be more lucrative than a corporate finance job at a corporation but it does come with
a greater likelihood that you will be laid off if you don’t produce results.

Not surprisingly, therefore, the decisions on how much risk to take and what type
of risks to take are critical to the success of a business. A business that decides to protect
itself against all risk is unlikely to generate much upside for its owners, but a business
that exposes itself to the wrong types of risk may be even worse off, though, since it is
more likely to be damaged than helped by the risk exposure. In short, the essence of good
management is making the right choices when it comes to dealing with different risks.






http://people.stern.nyu.edu/adamodar/pdfiles/valrisk/ch1.pdf

Risk Is Not a Four-Letter Word

VIEWPOINT May 5, 2010, 11:01PM EST

Risk Is Not a Four-Letter Word

Speculation has gotten bad press recently. But Businessweek.com's Frank Aquila says that for investors, avoiding risk may be the greatest risk of all

By Frank Aquila

While central bankers, small business owners, and stock market analysts rarely agree on much of anything, all appear to acknowledge that too much risk fueled the subprime mortgage bubble that led to the worst financial crisis since the Great Depression. The consensus view appears to be fairly simple and straightforward: risk is bad.

Certainly, foolish and excessive risk-taking can lead to financial catastrophe. But is all risk bad?

While excessive risk can indeed be dangerous, eliminating risk in any investing scenario is neither possible nor even beneficial. In the space of a few years, we have seemingly gone from a period in which no risk was too big, to a period in which no risk is too small. Fortunately or unfortunately, risk can never be truly eliminated, and in fact, an appropriate tolerance for risk is essential for meaningful economic growth.

RISK WILL ALWAYS BE WITH US
Since many more things could happen than will ever actually happen, some level of uncertainty will always exist. No matter how much care is taken in making any decision, a negative or unintended outcome is always a possibility. In short, risk will always be with us. Uncertainty may equate to risk, but that does not mean risk must always lead to danger.

As Peter Bernstein noted in his book Against the Gods: The Remarkable Story of Risk, the history of the modern world is marked by a "tension between those who assert that the best decisions are based on quantifications and those who base their decisions on more subjective degrees of belief about the uncertain future." So while proposals for financial and corporate governance reform strive to eliminate all risk, we need to ask whether artificial limits on all "risk" may actually create the greatest risk of all.

Consider for a moment a world in which the tolerance for risk is zero, or at least one in which perceived risk is heavily penalized. In a risk-intolerant environment, markets would require enormous returns on equity investments and significantly higher interest rates on debt for all but the safest "blue chip" borrowers. In such an environment, few new businesses would ever be started, funding of research and development would disappear for all but a handful of projects, and business development would slow to a trickle. Growth would simply be priced out of the market.

Since businesses today operate in a 24/7 global economy, it must be understood that "black swans" in obscure corners of the world could lead to unexpected, and possibly negative, consequences from Wall Street to Main Street. If excessive risk can be appropriately reduced, it is more likely than not that risk will lead to economic growth than it will to danger.

PRUDENT RISK: AN OXYMORON?
Risk is the fuel that feeds growth and the spark that permits creativity to flourish. But the acceptance of risk need not be synonymous with the acceptance of recklessness. So how do we avoid recklessness, without penalizing prudent risk-taking?

First and foremost, rewards must be tied to the risks being taken. Reward without risk is neither fair nor rational. The best, and perhaps most painful, recent example of imbalances that can result from risk/reward decoupling is the subprime mortgage crisis. The ability to pass along the risks to others is at the core of what created the subprime mortgage crisis. Mortgage brokers earned commissions by writing mortgages that were promptly resold, effectively decoupling the reward of the commission from the traditional risk of the mortgage holder: that interest and principal payments would be made on a timely basis until the loan was paid in full. Mortgage brokers were rewarded by writing mortgages, but they had no stake in whether those mortgages were ever repaid.

The logic that underpinned these mortgages was simple and seemingly incontrovertible: Home prices will always rise, so no matter what the price of the home sale or the terms of the mortgage, the transaction would be riskless. Ironically, one of the biggest hazards in modern financial history was created by millions of these "riskless" transactions, because at least in part, the risks were decoupled from the rewards at a crucial step in the chain.

Second, risk takers should be expected to act with discretion and intelligence, taking into account all the known facts and the relevant circumstances. When acting on behalf of others, a risk taker should be expected to act in the same manner as that person would with his or her own business or personal finances. The so-called prudent person rule is a long-established legal principle that has served us well. Risk takers, entrepreneurs, and inventors all create enormous wealth for the broader economy; their risk-taking should not be punished so long as they are being prudent. When investors and lenders finance these visionaries, particularly with other people's money, they must be expected to exercise discretion and due diligence and to dampen any unrealistic expectations that such entrepreneurs and inventors may have.

A VITAL INGREDIENT OF GROWTH
If we seek to eliminate risk, who will create the next Microsoft or Google? If we punish risk takers, will anyone invest in the next microchip or cellular technology? Or fund development of the next Lipitor or Celebrex? If governments will not support risk, how will the next Internet ever be created? Avoidance of excessive risk may well be necessary, but any attempt to eliminate risk would be the greatest risk of all.

Risk is an essential ingredient of economic growth. As legislators, regulators, and central bankers consider the causes of the financial crisis and ways to prevent the next one, it will be vital that they recognize that risk will always be with us and, in fact, that appropriate risk is a necessary evil. To paraphrase one of the silver screen's legendary investors, Gordon Gekko, "risk is good."

Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP.

http://www.businessweek.com/print/investor/content/may2010/pi2010055_924787.htm

The 4 major asset classes: the building blocks of any investment plan

Any serious investor should have a basic knowledge of the 4 major asset classes and the risk inherent in each:

• Cash - low risk  (For Savings and Protection)
• Bonds - moderate risk (For Income)
• Property - moderate to high risk (For Growth and Income)
• Equities - high risk (For Growth)

Remember this fundamental rule:

The bigger the risk you take, the greater the possible reward or return (growth on capital) you can expect.

The safer your investment and the smaller the risk you take, the smaller the possibility of a great return.

Risk Tolerance

Time is not the only factor that affects the risk you take when you invest.

Your own tolerance of risk is an important factor.

Risk is the measurement of your willingness to see your investments shrink in the short-term, even though you know they will increase in the longer term. 

You need to have some idea of your level of risk tolerance.

Volatility is not risk. Avoid investment advice based on volatility.

Redefining Risk

Risk was the chance that you might not meet your long-term investment goals. And the greatest enemy of reaching those goals: inflation. Nothing is safe from inflation. It's major victims are savings accounts, T-bills, bonds, and other types of fixed-income investments.

Investors usually use Treasury bills as their benchmark for risk. These are considered risk-free because their nominal value can't go down. However, T-bills and bonds are in fact highly risky because of their susceptibility to inflation.


Realistic definition of Risk

A realistic definition of risk recognizes the potential loss of capital through inflation and taxes, and includes:

1. The probability your investment will preserve your capital over your investment time horizon.

2. The probability your investments will outperform alternative investments during the period.


Why Volatility is not Risk?

Traditionally, investors view "risk" as being synonymous with "volatility." They believe that to get higher returns, they must be willing to stomach bigger short-term swings in a stock's price.

There is no correlation between this volatility-related-risk and return.

Higher volatility does not give better results, nor lower volatility worse.

Studies have shown that there is not necessarily any stable long-term relationship between volatility-related-risk and return, and often there is no relationship between the return achieved and the volatility-related-risk taken.

Volatility is not risk. Avoid investment advice based on volatility.


So if volatility is not risk, what is?

The major risk is not the short-term stock price volatility that many thousands of academic articles have been written about. Rather it is the possibility of not reaching your long-term investment goal through the growth of your funds in real terms. To measure monthly or quarterly volatility and call it risk - for investors who have time horizons 5, 10, 15 or even 30 years away - is a completely inappropriate definition. (David Dreman)


Take Home Lesson

Using Dreman's definition of risk, stocks are actually the safest investment out there over the long term.

Investors who put some or most of their money into bonds and other investments on the assumption they are lowering their risk are, in fact, deluding themselves.

"Indeed, it goes against the principle we were taught from childhood - that the safest way to save was putting our money in the bank."

http://myinvestingnotes.blogspot.com/2009/05/redefining-risk.html

The risk is not in our stocks, but in ourselves

Risk exists in another dimension: inside you. If you overestimate how well you really understand an investment, or overstate your ability to ride out a temporary plunge in prices, it doesn't matter what you own or how the market does. Ultimately, financial risk resides not in what kinds of investments you have, but in what kind of investor you are. If you want to know what risk really is , go to the nearest bathroom and step up to the mirror. That's risk, gazing back at you from the glass.

What should you watch for?

The Nobel-prize-winning psychologist Daniel Kahneman explains two factors that characterize good decisions:

• "well-calibrated confidence" (do I understand this investment as well as I think I do?)


• "correctly-anticipated regret" (how will I react if my analysis turns out to be wrong?).

To find out whether your confidence is well-calibrated, look in the mirrow and ask yourself: "What is the likelihood that my analysis is right?"


Think carefully through these questions:

• How much experience do I have? What is my track recrod with similar decisions in the past?


• What is the typical track record of other people who have tried this in the past?


• If I am buying, someone else is selling. How likely is it that I know something that this other person (or company) does not know?


• If I am selling, someone else is buying. How likely is it that I know something that this other person (or company) does not know?


• Have I calculated how much this investment needs to go up for me to break even after my taxes and costs of trading?

Next, look in the mirror to find out whether you are the kind of person who correctly anticipates your regret. Start by asking:

"Do I fully understand the consequences if my analysis turns out to be wrong?"



Answer that question by considering these points:

• If I am right, I could make a lot of money. But what if I'm wrong? Based on the historical performance of similar investments, how much could I lose?


• Do I have other investments that will tide me over if this decision turns out to be wrong? Do I already hold stocks, bonds, or funds with a proven record of going up when the kind of investment I'm considering goes down? Am I putting too much of my capital at risk with this new investment?


• When I tell myself, "You have a high tolerance for risk," how do I know? Have I ever lost a lot of money on an investment? How did it feel? Did I buy more, or did I bail out?


• Am I relying on my willpower alone to prevent me from panicking at the wrong time? Or have I controlled my own behaviour in advance by diversifying, signing an investment contract, and dollar-cost averaging?

You should always remember, in the words of the psychologist Paul Slovic, that "risk is brewed from an equal dose of two ingredients - probabilities and consequences."


Before you invest, you must ensure that you have realistically assessed your probability of being right and how you will react to the consequences of being wrong.





Ref: cc Intelligent Investor by Benjamin Graham

Risk comes from misjudgement of a company's prospects, not price volatility

Academics define risk as price volatility, and to counter that risk, they recommend holding a diversified portfolio.

But to value investors, like Warren Buffett, risk is the intrinsic value risk of a business, not the price behaviour of its stock. And intrinsic value risk, he says, comes from misjudgement of a company's prospects. He has extreme confidence in his ability to pick fundamentally strong companies which are trading at prices below their intrinsic value, and thus favours placing big bets on these companies.

You should have the courage and conviction to put at least 10 percent of your net worth into each investment you make, he says. "We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it," he explains.

Risk - the most difficult to quantify element (II)

If you reflect on Buffett's approach, you realize that the risk isn't inherent in the stock's price, but rather on the clarity and consistency of a company's future prospects.

The more unpredictable (hard to understand) the company and its future, the greater the risk.

There is no way to easily quantify this kind of risk.

Generally, business risks are accounted for in the discount rate by making a conservative assumptions - a high discount, or hurdle, rate - to provide a margin of safety.

Risk - the most difficult to quantify element (I)

Risk is perhaps the most debated, theoretical, difficult to quantify element of all. There are many types of risk in the business and investing world.

Investment books mention high beta stocks are riskier and low beta stocks are safer. However, beta is relatively meaningless for value investors. Why?

• Because it measures the fluctuation of stock prices.
• As a value investor, you aren't concerned with stock price fluctuation, only whether the stock price is a bargain compared to long-term value.
• Value investors ignore the type of risk measured by beta.
• They're more interested in how the company performs, not how the stock performs relative to other stocks.

Beta is useful only in the sense that higher price volatility for an issue may reflect underlying uncertainty in the company itself, such as with many of the higher flying tech stocks in 2000 and 2001. But the risks associated with these stocks become apparent long before you examine beta.

Redefining Risk

Traditionally, investors view "risk" as being synonymous with "volatility." They believe that to get higher returns, they must be willing to stomach bigger short-term swings in a stock's price. Volatility is not risk. Avoid investment advice based on volatility.

Redefining Risk

Risk was the chance that you might not meet your long-term investment goals. And the greatest enemy of reaching those goals: inflation. Nothing is safe from inflation. It's major victims are savings accounts, T-bills, bonds, and other types of fixed-income investments.

Investors usually use Treasury bills as their benchmark for risk. These are considered risk-free because their nominal value can't go down. However, T-bills and bonds are in fact highly risky because of their susceptibility to inflation.

For example, if you buy a 10 year-T-bill that pays 3 percent in interest per year, and inflation is creeping up at, say, 2 percent per year, the real value of your investment at maturity will end up being significantly less than 3 percent greater than the price you paid for it. In the case of low-interest-paying T-bills, higher inflation could even mean that your investment loses value, in terms of real purchasing power, over its lifetime.

Realistic definition of Risk

A realistic definition of risk recognizes the potential loss of capital through inflation and taxes, and includes:

1. The probability your investment will preserve your capital over your investment time horizon.

2. The probability your investments will outperform alternative investments during the period.


Why Volatility is not Risk?

Traditionally, investors view "risk" as being synonymous with "volatility." They believe that to get higher returns, they must be willing to stomach bigger short-term swings in a stock's price.

There is no correlation between this volatility-related-risk and return.

• Higher volatility does not give better results, nor lower volatility worse.
• Studies have shown that there is not necessarily any stable long-term relationship between volatility-related-risk and return, and often there is no relationship between the return achieved and the volatility-related-risk taken.

Volatility is not risk. Avoid investment advice based on volatility.

So if volatility is not risk, what is?

The major risk is not the short-term stock price volatility that many thousands of academic articles have been written about. Rather it is the possibility of not reaching your long-term investment goal through the growth of your funds in real terms. To measure monthly or quarterly volatility and call it risk - for investors who have time horizons 5, 10, 15 or even 30 years away - is a completely inappropriate definition. (David Dreman)

In the short-term, stocks fluctuate unpredictably, so if you're saving to buy a house or a car within the next two years or so, bonds and T-bills are a good choice. But over the long term, stocks far more often than not outperform alternative investments like bonds or T-bills.

In fact, Dreman's research shows that inflation-adjusted returns for stocks - which, unlike bonds or T-bills have the ability to produce increasing earnings streams - have consistently outpaced those of bonds and T-bills since the start of the 1800s. The gap has widened since the mid-1920s, when inflation began to have a more significant impact.

What's more, from 1946 to 1996, according to Dreman, compound returns after inflation for stocks were better than those of bonds 84% of the time if your holding period was 5 years.

• Stocks also outperformed T-bills in 82% of those 5-year periods.
• Using 10-year periods, stocks beat bonds 94% of the time and T-bills 86% of the time.
• When you look at 20-year holding periods, stocks beat both bonds and T-bills 100 percent of the time.

Take Home Lesson

Using Dreman's definition of risk, stocks are actually the safest investment out there over the long term.

Investors who put some or most of their money into bonds and other investments on the assumption they are lowering their risk are, in fact, deluding themselves.

"Indeed, it goes against the principle we were taught from childhood - that the safest way to save was putting our money in the bank."

How To Deal With Risk

How To Deal With Risk

People often do not properly assess the potential rewards for taking a risk. Nor do they focus on how well the risks and rewards match.

Your company faced a potential growth initiative that offers both high risk and high reward.


Ask yourself:

1. If you take this high risk and fail, will you lose the ranch?

If yes, you may not want to go ahead. If the risk is not of the bet-the-company type, then ask,

2. If you fail, will it put your company at a severe disadvantage?

Sometimes it is worth betting on a new initiative or idea, but you always want to have a handle on what you are up against. You also want to know how to reduce risk, shape it and manage it.


Convinced the risk is worth taking, you then drill down farther and decide whether the project is too risky, given the other risks in your company's investment portfolio.

Ask again and decide:

3. Would the inclusion of this project push the company over the edge?

If yes, and should you still decide to take the risk ahead, ask,

4. Would sharing the risk by an alliance be an acceptable option?

Understanding Risk and Return

Understanding Risk and Return

To get profit without risk, experience without danger, and reward without work, is as impossible as it is to live without being born. – A.P. Gouthev

Two key concepts provide the foundation for the field of finance.
1. A dollar today is worth more than a dollar tomorrow – this is the time value of money.
2. A safe dollar is worth more than a risk dollar.
The trade-off between risk and return is the principal theme in the investment decision.

RISK AVERSE: Most people are risk averse. This does not mean, however, they will not take a risk. It means they take a risk only when they expect to be rewarded for taking it. People have different degrees of risk aversion; some are more willing to take a chance than are others.

RISK NEUTRAL: Someone who is indifferent to risk is risk neutral.

RISK SEEKER: Someone who actively seeks out risky situations (a gambler) is a risk seeker.

• For small amounts of money, most people enjoy the thrill of a long-shot wager.
• For more significant sums, though, the tendency to risk aversion is nearly universal.

RETURN: People invest because they hope to get a return from their investment. Return is the good stuff that makes people feel better or improves their standard of living.

RISK: Risk is the bad stuff a risk averse person seeks to avoid. It is a fact of investment life and is unavoidable for anyone who seeks more than a trivial rate of return. Note that risk is a “four letter word.”

Risk and Return

Risk and Return


Any investor needs to ask themselves the following questions:

• How long can I invest for?
  


• What is the worst case scenario?
  


• Can I tolerate fluctuations in returns?
  


• What level of return do I need to match any future liabilities?
  


• Do I understand the characteristics of different asset classes?
  


• How do I achieve an objective investment process to meet my profile?

It is the mix of assets that drives returns. Some 75% of the return on a portfolio may be attributable to getting the choice of assets and geographical markets right over the medium term.



Our role as portfolio managers, once you have selected the portfolio, is to actively manage your assets in the global markets within the parameters we have established with you.


Remember this is your personal choice and reflects your emotional response to risk and your expectation of return.



Once you have decided where you feel most comfortable we can then determine the asset allocation that best matches your individual profile.



http://offers.telegraph.co.uk/content-10027/

Risk may be unavoidable, it is manageable.

Risk and Return

Sure, you'd like to make a fortune in the markets -- who wouldn't? The first thing you need to understand, before you commit even a dollar to a portfolio or begin surfing investing Websites, is that it's impossible to realize a return on any investment without facing a certain degree of risk.
According to Webster's, risk is the "possibility of loss or injury." In investing, risk is the chance you take that the returns on a particular investment may vary. That's another way of saying that there are no sure things when you're investing.
No matter what you decide to do with your savings and investments, your money will always face some risk. You could stash your dollars under your mattress or in a cookie jar, but then you'd face the risk of losing it all if your house burned possibly less dollars in real terms than when you started. Investing in stocks, bonds, or mutual funds carries risks of varying degrees.
The second fact you need to face is that in order to receive an increased return from your investment portfolio, you need to accept an increased amount of risk. Keeping your money in a savings account reduces your risk, but it also reduces your potential reward.
While risk in your portfolio may be unavoidable, it is manageable. The riddle of controlling risk and return is that you need to maximize the returns and minimize the risk. When you do this, you ensure that you'll make enough on your investments, with an acceptable amount of risk.

So, what constitutes acceptable risk?
It's different for every person. A good rule of thumb followed by many investors is that you shouldn't wake up in the middle of the night worrying about your portfolio. If your investments are causing you too much anxiety, it's time to reconsider how you're investing, and bail out of those securities that are giving you insomnia in favor of investments that are a little less painful. When you find your own comfort zone, you'll know your personal risk tolerance -- the amount of risk you are willing to tolerate in order to achieve your financial goals.
When it comes to your long-term financial future though, the biggest risk of all may simply be to do nothing. If you don't invest for retirement, or for the college education of your children, or to help meet your personal financial goals, then you're most likely guaranteed a future of just scraping by.

http://finance.yahoo.com/education/begin_investing/article/101171/Risk_and_Return

Capital Preservation is Key - CNBC Video

Capital preservation is key in such difficult times, says Fan Cheuk Wan, head of private banking research, Asia Pacific at Credit Suisse. Her advice to investors? Reduce your risk exposure and sell risky assets into any rallies.

http://www.cnbc.com/id/15840232?video=920838388

Related readings:
The risk is not in our stocks, but in ourselves
Consequences must dominate Probabilities