What is Risk? A Practical Perspective

0
What is Risk? A Practical Perspective

You and I use the word “risk” frequently in our lives, without really thinking about its definition or knowing whether others around us think of it the same way as us. Not having a specific definition of risk might be acceptable in a non-financial setting; but when it comes to investing, it is critical to have a clear definition of risk. Turns out that your definition of risk will determine how you select investments.

Academicians and financial marketeers (e.g. mutual funds, index funds, robo advisors, stock brokers) have directly or indirectly popularized a definition of risk that may be mathematically elegant, but does not do justice to the attributes that we intrinsically assign to our concept of risk. As human beings we are most concerned about the likelihood of a (permanent) loss (of assets) over a given time period. We aren’t necessarily worried about the temporary/transient variability of price trajectory over shorter intermediate periods. Yet this transient variability is what the financial services industry insists on calling risk, perhaps only because it can be measured easily. Furthermore, such a quantitative definition of risk also breeds obsessive focus o