Hello investors, speculators, advisors, fellow bloggers and especially, my readers. Today is the day that I jump right into the topic that I left you hanging with last week, the topic of risk.
Over the last three decades the question of risk arises on a regular basis. There seem to be so many different questions and applications associated with the word risk, especially when it comes to investing. And there seems to be a lack of a clear answer as to the real definition of the word and the action or actions associated with it.
Very briefly we will examine the definition of risk with my trusty friend, the dictionary. And as usual, we have a few interesting definitions of the word, interestingly, none of which have anything to do with investing. Just for arguments sake, and I do hope we raise the energy level about this topic for further debate, I will add the dictionary terms here and then I will tell you why there IS ABSOLUTELY NO RISK when investing.
From the Oxford Dictionary of Current English, 2001, risk has 3 definitions as a noun and 3 definitions as a verb. As a noun then, 1) a situation that could be dangerous or have a bad outcome, 2) the possibility that something unpleasant will happen, 3) a person or thing causing a risk: gloss paint can pose a fire risk. As a verb, 1) expose to danger or loss, 2) act in such a way that something bad could happen, 3) take risk by doing(something).
According to the above definitions that are not associated in any way with investing, the word risk is irrelevant when it comes to investing and does not even exist as far as I am concerned. The quote below comes from the Berkshire Hathaway Annual Report 1993 where Warren and Charlie discuss the word risk when addressing investing. Every advisor and investor (not speculator, which has been cause for an interesting debate on LinkedIn this past week) needs to have this cemented into their heads.
The strategy we’ve adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as "the possibility of loss or injury." Academics, however, like to define investment "risk" differently, averring that it is the relative volatility of a stock or portfolio of stocks - that is, their volatility as compared to that of a large universe of stocks. Employing data bases and statistical skills, these academics compute with precision the "beta" of a stock - its relative volatility in the past - and then build arcane investment and capital-allocation theories around this calculation. In their hunger for a single statistic to measure risk, however, they forget a
fundamental principle: It is better to be approximately right than precisely wrong. For owners of a business - and that’s the way we think of shareholders - the academics’ definition of risk is far off the mark, so much so that it produces absurdities. For example, under beta-based theory, a stock that has dropped very sharply compared to the market - as had Washington
Post when we bought it in 1973 - becomes "riskier" at the lower price than it was at the higher price. Would that description have then made any sense to someone who was offered the entire company at a vastly-reduced price? In fact, the true investor welcomes volatility. Ben Graham explained why in Chapter 8 of The Intelligent Investor. There he introduced "Mr. Market," an obliging fellow who shows up every day to either buy from you or
sell to you, whichever you wish. The more manic-depressive this chap is, the greater the opportunities available to the investor. That’s true because a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.
Why then do investors have to establish a risk profile before investing? Because the financial institutions that generate a KYC (Know Your Client) form now have an excuse to not be responsible for the advice their advisors suggest that results in a loss of capital and commissions from their clients. And that my friends is just stupidity. However, the financial giants thrive on their ability to trade millions of shares daily based on all sorts of propaganda
to ensure profitability for the shareholders. Profits at YOUR expense.
Copyright 2013 Richard M. Kiernicki. All Rights Reserved.
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