Redefining Risk
Risk was the chance that you might not meet your long-term investment goals.
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.
Short-term stock price volatility is not risk. Avoid investment advice based on volatility.
So if volatility is not risk, what is your major risk?
The major risk is not the short-term stock price volatility that many thousands of academic articles have been written about.
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.
Short-term stock price volatility is not risk. Avoid investment advice based on volatility.
So if volatility is not risk, what is your major risk?
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."
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.
