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Do you
speak riskese? Residents of China speak Chinese, citizens of Japan speak
Japanese, lawyers speak legalese and top-notch investment advisors, casino
statisticians, and insurance underwriters speak riskese. Riskese is the
language that’s used to discuss topics of risk, return, time, and
correlation.
Risk, return and time are all intertwined. Higher exposure to the right
risk factors leads to higher expected returns. The longer you hold a risky
investment, the more likely you will obtain the long-term expected return.
However, because of “random drift,” risk is very unpredictable
in the short run, but it can be quantified far more accurately than gut
feelings and intuition in the long run. For example, you can flip 10 heads
in a row with a coin, but there is still a 50/50 chance that you will
flip heads the next time and in the long run. Remember that if there is
no risk, there is no reason that you can expect a higher return than Treasury
bills, which have paid an annualized return of 3.8% per year for the last
70 years, just 0.5% over inflation.
High risk exposure is like a scream inducing roller coaster, with soaring
highs and stomach churning lows. On the roller coaster, the greater the
ups and downs, the greater the returns... measured in thrills. The same
thing applies to investing. However, not everyone has the “capacity”
for such “exposure” to risk. In this step the concepts
of risk, return and time will be explained.
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"
The average long-term experience in investing is never surprising,
but the short-term experience is always surprising. We now know
to focus not on rate of return, but on the informed management
of risk. " |
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Charles
Ellis, "Investment Policy," 1985 (a must read)
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Since the dawn of capitalism, there has been one golden rule:
"If you want to make money, you have to take risks. " |
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Opening
line of the Nova Special, "The Trillion Dollar Bet" |
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If your broker [or investment advisor] is not familiar with
the concept of standard deviation of returns, get a new one.
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William
Bernstein, "The Intelligent Asset Allocator" |
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