Decline in Market Price of holdings is not true risk or loss.

It is our conviction that the bona fide investor does not lose money merely because the market price of his holdings declines.  

Hence, the fact the decline may occur does not mean that he is running a true risk or loss.

If a group of well-selected common stock investment shows a satisfactory overall return as measured through a fair number of years then this group of investment has proved to be safe.

During that period, its market value was bound to fluctuate and likely than not, would sell for a while under the buyer's cost.

If that fall makes the investment risky, it would then have to be called both risky and safe at the same time.

This confusion may be avoided if we apply the concept of risk solely to a loss in value which:

• either is realized through an actual sale 
• or is caused by significant deterioration in the company's position 
• or more frequently, perhaps is the result of paying an excessive price in relation to the intrinsic worth of the security.

Many common stocks involve risks of such deterioration but it is our thesis that a properly executed group of investment in common stocks does not carry any substantial risk of this sort.


Ref:   Intelligent Investor by Benjamin Graham



Additional notes:

It is conventional to speak of good bonds as less risky than good preferred and that the latter as less risky than good common stocks.

From this was derived the popular prejudice against common stocks because they are not safe but we believe that what is here involved is not a true risk in the useful sense of the term.

If an investor's list has been competently selected in the first instance, there should be no need for frequent or numerous changes to the portfolio.

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.

Quantifying Uncertainty and Risk

Reducing Portfolio Risk

The challenge of successfully managing an investment portfolio goes beyond making a series of good individual investment decisions. 

Portfolio management requires 

• paying attention to the portfolio as a whole, 
• taking into account diversification, 
• possible hedging strategies, and 
• the management of portfolio cash flow. 

In effect, while individual investment decisions should take risk into account, portfolio management is a further means of risk reduction for investors.

Unlike return, risk is no more quantifiable at the end of an investment than it was at its beginning.

While security analysts attempt to determine with precision the risk and return of investments, events alone accomplish that.

Unlike return, however, risk is no more quantifiable at the end of an investment than it was at its beginning.

Risk simply cannot be described by a single number.  

Intuitively we understand that risk varies from investment to investment:  a government bond is not as risky as the stock of a high-technology company. But investments do not provide information about the risks the way food packages provide nutritional data.

Rather, risk is a perception in each investor's mind that results from analysis of the probability and amount of potential loss from an investment.

• If exploratory oil well proves to be a dry hole, it is called risky.  If a bond defaults or a stock plunges in price, they are called risky.  
• But if the well is a gusher, the bond matures on schedule, and the stock rallies strongly, can we say they weren't risky when the investment was made?  

Not at all.  The point is, in most cases no more is known about the risk of an investment after it is concluded than was known when it was made. 


There are only a few things investors can do to counteract risk:

• diversify adequately, 
• hedge when appropriate, and 
• invest with a margin of safety.  

It is precisely because we do not and cannot know all the risks of an investment that we strive to invest at a discount.  The bargain element helps to provide a cushion for when things go wrong.

Five investment hazards

Five investment hazards
After HSBC is fined for mis-selling investment bonds, we look at the products that tempt buyers to take inappropriate risks.

Investment hazards to avoid Photo: Alamy

By Emma Simon

7:00AM GMT 10 Dec 2011

As we draw closer to the ban on commission payments on financial products, which will take effect in 2013, there is growing concern about a rise in the mis-selling of products and fears that some advisers and salesmen are grabbing what they can now.

"I've never seen so many cases of poor advice as I have in the last six months – from advisers 'churning' pension plans to selling unregulated products such as overseas property investments," said Philippa Gee of Philippa Gee Wealth Management. In some cases, she said, advisers were pocketing between 8pc and 10pc of the investment.

"We never see clients who have been mis-sold a National Savings product or a cheap tracker fund," said Ms Gee. "Inevitably, they've been sold a product they don't fully understand and are taking too much risk with their money. But the adviser has received a generous commission fee for it."

Alarm bells should ring if any adviser recommends a product where there is a toxic mix of high charges, commissions and complex terms. This doesn't mean that there aren't certain cases where such products may be appropriate. But evidence suggests that these are few and far between. Despite this, such products are sold to thousands of consumers each year.

With less scrupulous advisers making hay while they can, and the difficult investment environment perhaps tempting consumers to take risks, we look at five products where you should always think twice before signing on the dotted line.

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Investment bonds

These made headlines this week when HSBC was fined £10.3m for selling bonds to elderly customers to pay nursing home fees. Regulators ruled that the bonds were mis-sold, given that the customers' average age was 83 and that there were penalties on withdrawals within five years, as well as a degree of investment risk.

These bonds aren't sold just to people needing long-term care. They are routinely offered to those with a sizeable cash sum to invest, whether they're saving for retirement or supplementing a pension. Ms Gee said: "Whenever I see a customer who's been ripped off, they've almost always been sold an investment bond."

These bonds are typically sold by insurers and allow customers to invest in a range of underlying funds. Their main advantage is that investors can withdraw 5pc of their capital each year without incurring a tax charge. But if the investment growth is less than this, capital can quickly deplete.

Most people are investing tens of thousands of pounds in these bonds (the average investment with HSBC was £115,000) and advisers earn commission of 6pc to 8pc. Investors should ask whether a diversified spread of low-cost equity or fixed-interest funds would be better. Ms Gee said: "Undoubtedly these bonds are oversold. I've advised hundreds of clients, but there's only one case I can think of where this was the most suitable product."

Structured products

These purport to offer a simple solution to nervous investors: get exposure to equity returns without putting your money at risk. Sadly, you will get far less than the market return (most investors don't get dividends, for example) and your capital could still be at risk.

Behind this persuasive "sell" are complex products that rely on derivatives and expose you to counterparty risk. Before signing up, make sure you are clear what the risks are and what return you will get. Santander recently sold "guaranteed" bonds which, it later admitted, weren't fully guaranteed, because of counterparty risk.

As with many types of investment, it's a mixed bag, with good, bad and downright ugly versions. Some structured deposits will be covered by the Financial Services Compensation Scheme (FSCS), so even if the bank selling it, or the counterparty underwriting the deal, went bust, up to £85,000 of your money would be protected. Others are "structured investments" where money can fall at twice the rate of the stock market in certain conditions. Always ask what the downside risk is, both in terms of market falls and the unlikely event of a bank backing it going bust.

"If you are not happy with stock market risk, I would not advise being in the stock market at all," said Ms Gee. "A well-diversified portfolio can often be a better way of managing such risks."

Multi-manager funds

Here, investors are paying a double layer of charges, often without any significant boost to performance. David Norman, the joint chief executive of TCF Investment, pointed out that the typical TER (total expense ratio) on unit trusts was 1.7pc, but on a multi-manager fund the average was 2.3pc, with many funds charging closer to 3pc.

These figures don't include dealing costs or any upfront fees. Some multi-managers don't include the charges on exchange-traded funds either, meaning the published TER may bear little resemblance to the charges deducted from your fund every year.

"Long-term investors are looking to beat inflation," said Mr Norman. "Historically, equities deliver 4.5pc more than gilts. But if you are paying more than 3pc to get a 4.5pc return, it's like trying to go up the down escalator."

These aren't just niche products, aimed solely at high-net-worth investors. Increasingly, these are the default options offered by a banks, including HSBC, Santander and RBS. Mr Norman added: "The principle of diversification is good, so these funds seem a simple, sensible option. But in a low-return environment it's important to keep an eye on costs. Most of these funds are charging too much."

Inflation-linked bonds

Popular at present are bonds where returns are linked to the retail prices index, rather than the stock market. With RPI now standing at 5.4pc and most banks paying less than 2pc, it's not hard to see why they are selling well. But investors should ensure they understand the more complex terms and conditions. If an account pays RPI plus 1pc, this does not mean you get 6.4pc today. Most are five-year accounts, and the return will be the difference in prices between now and the maturity date. Many people are expecting inflation to fall next year, once the rise in VAT drops out of the year-on-year calculation. As with structured products, there may be counterparty risks as well, although most are "structured deposits" that will be covered by the FSCS.

Exchange-traded funds (ETFs)

ETFs don't pay commission and have very low charges. So how can consumers go wrong? Sadly, they are far from simple products. There are physical ETFs, where the manager holds the shares or commodities of the index being tracked. But there are also synthetic versions, where there can be tracking errors and problems with liquidity if too many holders try to sell quickly. Many of these rely on complex derivatives. Worse, some offer "geared exposure", where the fund borrows to boost returns – but this can magnify losses if the market is against you.

Richard Saunders, the chief executive of the Investment Management Association, warned customers to make sure they knew what type of ETF they were buying. The term ETF is often used to describe their riskier cousins, known as exchange-traded products (ETPs), which don't offer the same level of investor protection. Investors should also ensure they look at all charges. The iShares FTSE 100 ETF has an expense ratio of only 0.4pc but annual platform charges make it more expensive than the Fidelity Moneybuilder UK Index fund or the Vanguard FTSE UK Equity Index fund.

Gary Shaughnessy of Fidelity said: "Fees reduce the value of your investments, so everyone should be clear about what they are paying. It's like deciding to fly with a flagship airline or its no-frills rival. There's more to the comparison than the eye-catching price in the advert. If you've been stung by extra charges for baggage, checking in and so on, you know that what matters is the total cost."


http://www.telegraph.co.uk/finance/personalfinance/investing/8946740/Five-investment-hazards.html

Risk versus Safety

Learn to Manage Risk

Several investors clamour for risk-free products, assurances, guarantees and promises. But just as we do not have perfect spouses and perfect jobs in the real world, we don't have risk-free investment products as well. So, we must understand and manage risk in our investments.

We all invest our capital in an enterprise or a business activity. The entity with which we entrust our capital uses it to create assets. The primary source of business risk is that despite the assets being managed well, their performance is subject to multiple, unknown factors . The ability of the enterprise to service and return our capital is impacted by these risk factors. If a bank deposit is seen by investors as safe and risk-free , this comes is due to the the bank's capital to bear any risk arising from the assets it has funded with those deposits.

The only other way to ensure that an investment is risk-free is to back it by sovereign guarantee. The government is not expected to default because it can raise taxes, borrow internationally, or in the worst case, print currency notes. However, the Indian government no longer guarantees any investment product other than its own borrowings through the issuance of government securities, for funding the deficit in its annual income and expenditure. The products offered under the National Savings Schemes are the only exception.

To the investor who is seeking safety, government bonds and savings schemes are the first choice. However , the returns from these products may be quite low, exposing the investor to inflation risk, thereby making it unsuitbale for long-term investors. The investors who seek fixed return and relative safety of principal can invest in deposits, bonds and certificates issued by borrowers such as banks and companies. The risk of default is inherent in these instruments. It can be managed only by choosing and monitoring the quality of assets of these businesses and the adequacy of equity capital to bear those risks. Credit rating agencies offer rating services to gauge these risks. However, investors may still face the risk of illiquidity of such investments.

The investors who are willing to take on business risks by directly investing in equity of enterprises bear the risk arising from the changing quality of assets. They can take this risk only if they are provided adequate , accurate and complete information about how the assets are performing. They should be able to assess their business risk on a continuous basis and quit if they are uncomfortable with the changing levels of risk. This is why equity investors can sell their equity in a stock market where it is listed. But in this case, they are exposed to the market risk. Every investment is exposed to risk and each of these is of a different nature. If equity bears direct business risk, in case of debt, it is of an indirect nature as a possible default. If non-government debt is exposed to default risk, government debt is open to inflation risk. The only time-tested strategy to manage investment risks is diversification. Holding assets that are exposed to different risk factors reduces the overall risk of the investment portfolio. Rather than running away from risk, we must understand and use it to our advantage.

The author is MD, Centre for Investment Education and Learning, and can be reached at uma.shashikant@ ciel.co.in

Do yourself a favour, invest in your financial education before you invest in the markets

"Risk comes from not knowing what you are doing." 

Risk can be alleviated with proper education and experience.  This is the same process that you must commit to undertake when you decide to invest in any market.  First and foremost, you must get yourself educated.

It is strange that most parents would not think twice to pay high school fees to send their kids to university, when there is no real guarantee that they will succeed in life after getting their degree.  However, when it comes to paying for financial education, where there is a chance they can lose all of the kids' education funds, many people shy away because of the price.  Instead, they would rather risk their hard earned money in a market or instrument that they have little knowledge of, or worse, investing based on rumours or tips from various unverified sources.

Most people are attracted by the myth of quick, easy money from investing (or trading) but fail to understand that it takes a lot of hard work to be successful.  Everyone equates being a doctor or lawyer to earning lots of money.  But it is also common understanding that to be a doctor or a lawyer requires one to put in many years of education and practice before one can be successful.  Ask anyone about his or her current job and you would most likely get the same response that hard work is the norm.  How then can it be different for investing (and trading)?

"Risk comes from not knowing what you are doing" - a famous quote from Warren Buffett.  
It sounds simplistic, but it epitomises the real meaning of the work "Risk".

Any instrument, be it stocks or forex will be dangerous if you don't know what you are doing.  it is not the instrument but the level of the investor's understanding of the instrument and the market that determines his risk level.  So, do yourself a favour, invest in your financial education before you invest in the markets. 

Here is another quote from Mr. Buffett:  "The most important investment you can make is in yourself.."

The Risk is Not in The Car; It is the Driver Behind The Wheel.

It would be a risky situation if a person decides to drive a car without having undergone any form of training.  It is the person's lack of knowledge and skill that makes the situation risky and not the car.

Similarly, if someone wants to invest (or trade) in a particular instrument but has not undergone any form of training, this person would be assuming a higher risk, and it has nothing to do with the instrument.  It is often the lack of knowledge and skill that makes investing (and trading) risky and not the instrument itself.


What is risk in the context of investing?

Risk is a quantifiable entity.
People associate risk with uncertainty in outcome or expected return.  A fixed deposit gives an expected return that is certain but not stocks.
People associate risk with volatility.  Yes, this too can be risky for those who do not understand volatility and who fall folly to it, rather than taking advantage of it.


Risk in investing is thus generally defined as:  


"The quantifiable likelihood (probability) of loss or less-than-expected returns."  
The keyword here is uncertainty in outcome or expected returns.

How to be a good investor?

To be a good investor (and trader), one must first seek knowledge about the instrument that one is going to invest in (or to trade).  It is similar to taking on a new job.

• First, you must learn what your new role is all about, what kind of tools are there to help you in your everyday routines, what are the skill sets needed to perform your new job properly, etc.  
• After that, once you have acquired the knowledge and learnt the skills required, you still need a period of constant practice to apply your newly acquired knowledge and hone your new skills.  
• It is only after having practised for a sustained period of time before one is able to get the "feel" of the job and perhaps do it with ease and confidence.

Risk comes from NOT knowing what you are doing.
Enter at your own risk.

The Best Way to Minimize Risk of Your Portfolio: Asset Allocation

The best way to minimize the risk of your portfolio is to carefully balance your assets among various investment vehicles.  Many people think that seeking out the top-performing stocks and mutual funds is the key to successful investing.  They are wrong.

Study after study has shown that individual investment choices account for only 5 or 10 percent of a portfolio's success, while 90 to 95 percent can be attributed to the way the portfolio is allocated among stocks, bonds and money market instruments.

Five Factors of Asset Allocation

When you plan to allocate your assets, you must consider five key factors:

1. your investment goal, 
2. your time horizon,
3. your risk tolerance,
4. your financial resources, and 
5. your investment mix.

The three most important personal factors to consider: Your Time Horizon, Risk Tolerance and Investment Objectives.  Read more here:  How well do you know yourself.

Your financial resources relate to HOW MUCH money you have to invest.  The amount of money you have to invest will be a big factor in the risks you want to take.  A small investor just doesn't have the funds to properly diversify a portfolio.  In that case, a well-diversified mutual fund is your best bet for getting started.  Once your portfolio has grown large enough, you may want to take some risk by selecting a more aggressive mutual fund or picking individual stocks.

Your investment mix relates to how you will ALLOCATE what you have to invest.  Historically, the rate of return for large-company stocks has averaged 11.3% between 1925 and 2000.  During the same period, bonds averaged 5.1% return and cash savings averaged 3%.  Rates of return are even higher for small company stocks, but they are also much more volatile.

What chance does your current asset allocation have of meeting your goals?


A portfolio balanced for growth would likely have 60% stock, 20% bonds, and 20% cash.  Using these returns as the average, the portfolio would likely earn 8.4% before taxes and inflation. This is what is called a weighted average.

This is how it works:

60% stock at 11.3%
11.3 x 0.60 = 6.78%
20% bonds at 5.1%
5.1 x 0.20 = 1.02%
20% cash at 3% 
3.0 x 0.20 = 0.60%
Total = 8.40%

You can group your portfolio into these types of baskets and get a weighted average of the return you might expect from the portfolio.  If you have mutual funds, they should calculate what percentage of stock, bonds, and cash are held within the fund.  You can use those percentages when you want to compare this in your portfolio.

Use this information to decide how balanced your portfolio really is and whether that balance matches your savings goals and your risk tolerance.  What chance does your current asset allocation have of meeting your goals?

If your gap is huge and you know you can't meet your goals with the current estimated level of return, you must decide whether 

1. you can tolerate more risk and try to improve your portfolio's growth potential or 
2. revise your goals to a level that more realistically matches what your portfolio can achieve.

Related:
Your Time Horizon, Risk Tolerance and Investment Objectives.  How well do you know yourself?
http://myinvestingnotes.blogspot.com/2010/01/three-most-important-personal-factors.html

Understand what money means to you:  Answer 10 simple questions
http://spreadsheets.google.com/pub?key=tr9oMvjAsDJvkcPgXdd763A&output=html

Don't be afraid of risk. Learn how to manage it.

Don't be afraid of risk. You will face some kind of risk no matter what you do with your money. Fear of risk can sometimes paralyze your investing. You end up watching your money lose value solely because you missed investment opportunities and let the money sit in a safe savings account, earning less interest than the inflation rate.

The least you need to know:

1. Get to know the types of risks you face as  a value investor, but don't be afraid of them.
2. No investor can avoid risk, but you can learn how to manage it.
3. Time can heal many investment woes, as long as you have the patience to wait out an investment storm.

Risk and Uncertainty

Risk

What is risk?

In financial terms, risk is the probability of an investment's actual return being lower than expected.

Can we understand risk and take actions to lower it?

We now have the two elements necessary to start us on a path of business risk management.

How can we:

(1)  lower the potential downside of risk

and/or

(2)  lower the probability of occurrences?

Risk can be both

• intrinsic (within ourselves) and 
• extrinsic (from outside).  

If risk is the potential for a business loss, when may a business project be deemed a high risk?

A business project may be deemed a high risk because either:

(1)  there is a high likelihood of a loss of any size, 

or

(2)  there is even a very small likelihood of a large loss.  

Almost every business action carries some degree of risk.  High-risk actions require careful management because of their potential large negative consequences to the business.

Threat:  A threat is a potential event with a very low probability but a high negative impact.  

"Bet-your-company risk":  Avoid taking a "bet-your-company risk."  The potential negative consequences of such a risk are just too, too large.  For example, a bet-your-company risk would be spending all your available resources on developing a risky new product.  The company could fail if development were to be delayed or if sales were much lower than projected. 

However, entrepreneurial companies usually must face bet-your-company risks as they start up and grow.  Understanding and managing risk and uncertainty is especially important in these fledging enterprises.  Startups must be focused, innovative, responsive and also very lucky to survive.  Most often, they are not.

Uncertainty

"Uncertainty" is different from risk.  

Uncertainty is not knowing what the future will bring.  However, under the cloak of uncertainty, high risk can lurk.  Thus, lowering uncertainty can lower risks too.

Uncertainty can be more dangerous than risk.  Because we often know the elements of risks, we can plan for risk and take measures to mitigate the negative consequences of risk.  However, with uncertainty we are often flying blind.  It is hard to lower uncertainty if you do not know what it is and thus what to do to lower it.  

Quotes:  

"The consequences of our actions are so complicated, so diverse, that predicting the future is a very difficult business indeed."

"The best way to predict the future is to invent it."

"It's tough making predictions, especially about the future."

Related:
Risk and uncertainty in investing.  Investing is serious business.

Investing Money in Plain English (Video)

Risk in Stock Market – Stock Market Risk Management

Risk in the stock market is everywhere. Investing in the stock market is fraught with worry, for good reason. If you lose half of your investment, you must double your return to just breakeven. Warren Buffett, considered by many to be the world’s greatest investor, states his first rule of investing is “do not lose money.” Unfortunately, the risk in the stock market of losing your money is always a possibility. However, without taking some risk there is no reward. Therefore, successful investors employ stock market risk management strategies to minimize their losses. Managing risk in stock market starts with identifying the type of risk and taking action to mitigate the impact of the risk on your investment portfolio.

Risk in the stock market comes in many forms and each can lead to a loss. The most common is the overall trend of the market. Approximately 60 % of the move of an individual stock is attributed to the trend of the stock market. If the stock market is rising, it takes with it most of the other stocks, though not in equal amounts. When the stock market falls, stocks sink with it.

Another big risk in stock market lies with owning an individual stock. While owning the stock of a company can offer greater rewards, it also entails the risk that something might go wrong that can cut the price of the company’s shares in half. It might be news that sales have suddenly fallen due to a new competitor, or a product liability issue has arisen. For whatever the reason, individual stocks are subject to risk associated to them alone.

While there are other risks in the stock market, these encompass the vast majority of the ones you will encounter. Fortunately, investors can employ several strategies as a part of their stock market risk management program.

http://pediaworld.com/risk-in-stock-market-stock-market-risk-management/

Responding to risks: Eliminating risks

Clearly, if a risk has potentially negative consequences, then eliminating it is the best alternative. Given the choice, we would like to live without the potential for downsides to occur.

In business terms, this is clearly the most desirable action to take - it reduces management effort both now and in the future if you don't have to worry about a particular risk any more.  However, this is seldom possible - few risks can be eliminated completely, and some risk is going to be present in nearly every business situation.,

The key to considering elimination is the risk profile.  As we've seen, any risk that involves a fatal downside is a strong candidate for elimination, since the occurrence of the downside, however low its probability, is totally unacceptable. 

We would not choose to play a dice game that might bankrupt us.  In business terms this might equate to changing manufacturing processes that endangered people's lives in some wqay.  However unlikely the outcome, it would not be acceptable simply to tolerate the risk. 

Eliminating a risk may involve doing things in completely new ways.  If significant business change is involved in getting rid of a risk, you may need to consider what new risks will be created as a result.