Define risk

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Slim2None's picture
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Joined: 2006-04-14

In 3 or 4 sentences, define risk to a new investor.

Philo Kvetch's picture
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Joined: 2005-05-17

The chance you take for the profit you can make.

(Sorry. I couldn't resist.)

san fran broker's picture
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Joined: 2006-02-25

In a diversified portfolio, risk is defined as how widely returns in any given year can be expected to vary. A higher risk portfolio will experience wider swings in value, but also have a higher average rate of return. A diversified portfolio with a high level of risk may take a long time to reward the investor with a higher rate of return, as much as 15 or so years. At some point, the relationship between risk and return worsens - that is, the rate at which return increases relative to risk diminishes and the increased level of return only comes at a much greater degree of variability of those returns.

Starka's picture
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Joined: 2004-11-30

san fran broker wrote: In a diversified portfolio, risk is defined as how
widely returns in any given year can be expected to vary. A higher risk
portfolio will experience wid

This is about the point where you lost the new investor.

troll's picture
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Joined: 2004-11-29

Starka wrote: san fran broker wrote: In a diversified portfolio, risk is defined as how
widely returns in any given year can be expected to vary. A higher risk
portfolio will experience wid

This is about the point where you lost the new investor.I agree.  Philo's description, even though somewhat tongue in cheek, is much better.

My Inner Child's picture
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Joined: 2006-10-08

Slim2None wrote:In 3 or 4 sentences, define risk to a new investor.
Why bother?

anonymous's picture
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Joined: 2005-09-29

Risk: The chance that a given strategy won't achieve one's financial goal.
ie. A bank account is not a risky "investment" if the purpose of the money is to buy a house in 2 weeks.  A bank account is a very risky investment if the goal is to retire at age 60 because the "investment" in some cases will guarantee that the person can't achieve their goal.
 

BondGuy's picture
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Joined: 2006-09-21

How do I define risk?
Riding a motorcylce at warp speed? Nah
Sailing a 16 foot boat through 20 foot breakers? Nah
Jumping off a perfectly good mountain strapped to a Hang Glider? Nah
By far the most dangerous thing a person can do:
Drive the speed limit on the New Jersey Turnpike. Now that's risk!

babbling looney's picture
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Joined: 2004-12-02

OK more than a few sentences, but this is something like what I use when doing an initial client interview.
Mr. Client.  Risk can be defined in many ways and each person has certain risk tolerances and levels.  People consider risk to be the risk of losing money and seeing their account value go down because the market has gone down. Of course we don't want to lose money!! Some investments are riskier than others so that when they go up they go up a lot AND when they go down they go down a lot too. 
Some investments have no principal risk like Bank CDs and will only up in value.  People feel pretty safe in CDs don't you agree? But that doesn't mean that there is no risk in a Bank CD.  The risk there is that your gains from the interest credited will not beat inflation and you end up losing in the future when your dollars buy less than they can today.
My job is to help you decide just what level of risk you are willing to accept and how much return on your money you would like to obtain and then find the right investments to suit your particular circumstances.......
blah blah blah investments....blah blah blah... questions for client....goals.....time frame.....net worth..... set goals....set expectations of me... expectations of them.....etc etc.  

scrim67's picture
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Joined: 2005-04-28

My closest explanation is BB's.
I measure risk tolerance primarily by asking a client what is the lowest they are willing to see their portfolio drop in a one year period.
I combine that answer with when they plan on using the assets and come up with some kind of solution.
scrim

apprentice's picture
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Joined: 2006-06-06

Simple - show clients this formula for calculating risk.  They'll look at it for a minute or two - then they'll start writing you a check.



where:

  • ä(x) = estimator
  • è = the parameter of the estimator

  • x = observables

  • L - expectation value of the loss function

planrcoach's picture
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Joined: 2006-12-13

( Sorry, this is way more than three sentences.)
You hired me to help you manage risk - so you can make just a little more that putting your money in a savings account.
Just making a little more - without losing your money, that takes a lot of work.
Being disciplined, just doing the actual service on the investments, not being greedy, that' why you are paying me the "big bucks."
Here's my left hand - it represents stocks. Stock mean ownership. Owners get paid about twice as much as lenders, over a long period of time. Stock ownership, just like you own your house - that helps combat inflation. Inflation is just as dangerous as losing your money in a bad investment.  
(Five fingers). One year the market goes up. this finger, this year the market goes d down, these two, the market goes sideways. This one, I don't know. Noboby knows.
Right hand - here are your fixed investments - you are lending your money to someone else. You don't get paid as much as ownership, but if things fall apart, they won't go down is much.
(Five fingers). Things like: CDs, money market, cash, government bonds, even things like guaranteed annuities.
Did you know there are about five kinds of bonds: U.S. government bonds, high quality and low quality company bonds, inflation protected government bonds, international bonds - bonds of developed countries like Europe and developing countries like Brazil, what about the bonds of local governments all across the U. S., backed by the taxing power of local governments?
I guess that' more than five.
Anyway, if you put these two hands together, in the right way, well, you should be able to sleep at night.
Last year was a really great year - a portfolio with stocks and bonds, maybe it went up ten percent - it got much of the return of the stock market - but with a lot less "risk".
So the question is, how well can you sleep it night, because when things fall apart, and they will, it will be painful?
(Listen, find out what they were doing in the last down market, ask them how they will feel when their statement shows $30,000 less, can they really handle it.)
Even if you have a lot of "fixed", it will still be painful, and we have to endure it together, I'll especially be calling you when the market goes down. Because, if you tell me to change the program then, you will fail.
(Fill out " 7 questions" on Morningstar Risk Profile, show model portfolio, document risk tolerance.)
Question #7, "Which of these statements would best describe your attitudes about the next three months performance of this investment."
Well, your uncertainty on how to answer is interesting, because a lot of people feel the way you do, but you know, they do end up picking, like you did, " If I suffered a loss of greater than 10%, I'd get concerned."
And so on.

AllREIT's picture
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Joined: 2006-12-16

Slim2None wrote:In 3 or 4 sentences, define risk to a new investor.

What you will encounter if your advisor can't define risk to a new investor in 3 or 4 sentences.

planrcoach's picture
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mranonymous2u's picture
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Joined: 2006-11-29

Risk is not getting to the destination you expected to when you started out. There are an infinite number of reasons that this may happen, each reason has it's own percent of probability of happening. The risks to your particular portfolio depend on how you define your destination. If you define you destination as having the same amount of money (or, say, 50 percent more money) in ten years as you have today then the risks are defined by the rate of return. We can buy a 10 year cd with a 5% coupon and you will have achieved your destination. However, if you define your destination as "I want to be able to buy the same things in ten years that I can buy today with this money," the same solution may not work. As such the safe investment may have has now presented an insurmountable obstacle and your portfolio must be designed in other ways.
You didn't say they had to be simple, short sentences! 
Mr. A

mranonymous2u's picture
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Joined: 2006-11-29

As such the safe investment may have has now presented an insurmountable obstacle and your portfolio must be designed in other ways.
Should be: As such, the safe investment may have now presented an insurmountable obstacle and your portfolio must be designed in other ways.
We can buy a 10 year cd with a 5% coupon and you will have achieved your destination.
Could have added: ... with the only risk being that the FDIC stops backing all bank's cds, which is an infinitessimal risk.
Could add, but prolly shouldn't.
Mr. A

planrcoach's picture
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Joined: 2006-12-13

In 3 or 4 sentences, define risk to a new investor.
The market goes up, and you aren't in it. (inflation)
The market goes down, and you sell stocks or bonds at exactly the wrong time.
The market goes sideways, and you don't have enough money that generates dividend income.

Slim2None's picture
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Joined: 2006-04-14

babbling looney wrote:OK more than a few sentences, but this is something like what I use when doing an initial client interview.
Mr. Client.  Risk can be defined in many ways and each person has certain risk tolerances and levels.  People consider risk to be the risk of losing money and seeing their account value go down because the market has gone down. Of course we don't want to lose money!! Some investments are riskier than others so that when they go up they go up a lot AND when they go down they go down a lot too. 
Some investments have no principal risk like Bank CDs and will only up in value.  People feel pretty safe in CDs don't you agree? But that doesn't mean that there is no risk in a Bank CD.  The risk there is that your gains from the interest credited will not beat inflation and you end up losing in the future when your dollars buy less than they can today.
My job is to help you decide just what level of risk you are willing to accept and how much return on your money you would like to obtain and then find the right investments to suit your particular circumstances.......
blah blah blah investments....blah blah blah... questions for client....goals.....time frame.....net worth..... set goals....set expectations of me... expectations of them.....etc etc.   I like that; turn it around, and show them the what can happen if you don't take any risks (grow poor safely).

Slim2None's picture
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Joined: 2006-04-14

planrcoach wrote:( Sorry, this is way more than three sentences.)
You hired me to help you manage risk - so you can make just a little more that putting your money in a savings account.
Just making a little more - without losing your money, that takes a lot of work.
Being disciplined, just doing the actual service on the investments, not being greedy, that' why you are paying me the "big bucks."
Here's my left hand - it represents stocks. Stock mean ownership. Owners get paid about twice as much as lenders, over a long period of time. Stock ownership, just like you own your house - that helps combat inflation. Inflation is just as dangerous as losing your money in a bad investment.  
(Five fingers). One year the market goes up. this finger, this year the market goes d down, these two, the market goes sideways. This one, I don't know. Noboby knows.
Right hand - here are your fixed investments - you are lending your money to someone else. You don't get paid as much as ownership, but if things fall apart, they won't go down is much.
(Five fingers). Things like: CDs, money market, cash, government bonds, even things like guaranteed annuities.
Did you know there are about five kinds of bonds: U.S. government bonds, high quality and low quality company bonds, inflation protected government bonds, international bonds - bonds of developed countries like Europe and developing countries like Brazil, what about the bonds of local governments all across the U. S., backed by the taxing power of local governments?
I guess that' more than five.
Anyway, if you put these two hands together, in the right way, well, you should be able to sleep at night.
Last year was a really great year - a portfolio with stocks and bonds, maybe it went up ten percent - it got much of the return of the stock market - but with a lot less "risk".
So the question is, how well can you sleep it night, because when things fall apart, and they will, it will be painful?
(Listen, find out what they were doing in the last down market, ask them how they will feel when their statement shows $30,000 less, can they really handle it.)
Even if you have a lot of "fixed", it will still be painful, and we have to endure it together, I'll especially be calling you when the market goes down. Because, if you tell me to change the program then, you will fail.
(Fill out " 7 questions" on Morningstar Risk Profile, show model portfolio, document risk tolerance.)
Question #7, "Which of these statements would best describe your attitudes about the next three months performance of this investment."
Well, your uncertainty on how to answer is interesting, because a lot of people feel the way you do, but you know, they do end up picking, like you did, " If I suffered a loss of greater than 10%, I'd get concerned."
And so on. Cool.

Slim2None's picture
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Joined: 2006-04-14

I appreciate all the responses and feedback. I know it sound silly, but helping a client understand risk and all it's implications is not as simple as it seems.

planrcoach's picture
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Joined: 2006-12-13

I like that; turn it around, and show them the what can happen if you don't take any risks (grow poor safely).
Looney brings up a key point. Slim2, you can point out that inflation is just one other form of risk, there are all kinds of risk: inflation risk, interest rate risk (up or down). Individual security risk can be removed by using mutual funds. There geopolitical risk, the risk that you will live too long and run out of money. Risk comes from all directions. Sometimes, we deal with risk (a threat) with "fight or flight". Our brains are wired to act emotionally. Your training and experience as an advisor allow you to help the client act rationally and effectively to the various threats posed by "risk".

AllREIT's picture
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Joined: 2006-12-16

planrcoach wrote:I like that; turn it around, and show them the what can happen if you don't take any risks (grow poor safely).
Looney brings up a key point. Slim2, you can point out that
inflation is just one other form of risk, there are all kinds of risk:
inflation risk, interest rate risk (up or down).

The way I explain risk to people is by doing it the way insurance companies do.

We talk about Possible Maximum Loss x Probability of Max Loss, and then we talk about probable losses and so forth.

I introduce the concept of  portfolio drawdowns  and discuss
what would be the probable max drawdown in a portfolio with a given
asset allocation.

I explain that inflation results in a sure thing loss, the PML is low
(only 2-3%) but the P(loss) is 1. Therefore in managing money we strive
to do better than inflation, and better than the risk free rate.

MStyle88's picture
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Joined: 2006-04-04

Easy- Uncertainanty regarding loss. Thats it.

babbling looney's picture
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Joined: 2004-12-02

MStyle88 wrote:Easy- Uncertainanty regarding loss. Thats it.
That easy is it?  Then everyone should have a bank certificate of deposit.   You can't lose any principal there.

mranonymous2u's picture
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Joined: 2006-11-29

Or penny stocks, that way you've taken the uncertainty out of the mix. You ARE going to lose ALL your money!
Mr. A

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