Risk, Its Management and Disclosure

Risk, Its Management and Disclosure
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An investment is the act of exchanging money for a security which confers title to a business, debt or building. In such a transaction, the investor typically incurs inconvenience – namely, the money required to buy a capital good (such as a stock or bond or title to real estate) cannot be used to buy a consumer good or service (such as a house or motor car or overseas holiday). To invest is thereby to defer current gratification.

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The investor is prepared to wait because he believes that the investment will generate certain benefits over time, and that these eventual benefits will outweigh the inconvenience incurred in the meantime. One exchanges cash today for (say) a title to a commercial building because one expects that the property will generate a stream of earnings (i.e., regular payments of rent) sufficient to finance some desired level of consump-tion tomorrow, the day after and into the indefinite future. The investor post-pones the consumption of jam today so that (he hopes) he can consume more jam (or give it to others) tomorrow. In Warren Buffett’s words, “investing is laying out money now to get more money back in the future – more money in real terms, after taking inflation into account.”

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To invest is necessarily to make assumptions about the future. But tomorrow is always uncertain and our assumptions about it never correspond perfectly to the eventual reality. As a result, an outlay of cash today will almost certainly not generate a stream of income that corresponds precisely to one’s projections. There’s a significant chance that the stream will fall well short of expectations; and there’s some chance that it will produce no stream at all. Hence risk – the chance that one’s plans go awry – underlies any investment.

According to the mainstream, the greater is the anticipated return from an investment the greater is its risk.

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Via: csinvesting


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