30 July 2012

More About Risk

I spend a lot of time considering and explaining risk in connection with my investment advice. Most of the time we are using "risk" as a shorthand to mean "volatility" - for example, higher "risk" investments are expected to go up and down in value more, but over the long term they are also expected to rise further than lower risk investments.

However, there is more to risk than that. Here's my summary - each of these may need to be considered before investing:
  • Volatility (capital) - how much will the investor see their invested value go up and down? Or, to put it another way, what is the likelihood that it will be down when they want to surrender their money?
  • Volatility (income) - if a regular income is being taken, how well can the investor cope with a variable income?
  • Capital loss - how likely is it that some or all of the value will be permanently lost? You could invest in a small company (low volatility = low "risk" in theory) but your investment could be lost entirely if the company fails
  • Inflation risk - how much of a problem could this be for the investor?
  • Liquidity risk - is it possible that you will not be able to surrender when you want to?

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