What does risk mean to you?

Investment industry folks like to talk about risk in terms of ‘volatility’, which essentially means the variability of the value of an investment through time. They may talk about ‘drawdowns’ or ‘value at risk’, which are a bit closer to what risk really means. But these measures are merely convenient proxies for genuine risk. In assessing the risk of your own investments and considering your own risk tolerance, you should think about risk in a more meaningful way.

So what does risk mean to you? If you have a financial advisor, they should be asking you that question, not answering it for you. If you don’t have a financial advisor, then you should be asking yourself the question. It’s not an easy question but let me give you some prompts to help you think about your answer.

Firstly, what are you trying to achieve by investing? Ultimately, not achieving that objective is a failure. The likelihood of that happening is one way of thinking about risk. If you’re not trying to ‘achieve’ something, but instead trying to meet an expense or an obligation, then the likelihood of not meeting your obligation is a meaningful way to think about risk. Many of you won’t be trying to ‘achieve’ or ‘meet’ anything, and instead you’re just trying to make as much money as you can. In that case, not making any money or losing money will leave you disappointed. The likelihood of being disappointed is a good way to think about risk.

It should be clear that your feelings about what risk means to you is directly related to your objective. Risk is the thing that you need or want to happen not happening. But we need to get translate this ‘feeling’ about risk into a more concrete investible action. Again, if you have a financial advisor, they should know how to do this part (they probably don’t). If you don’t have one, you’re on your own, and that’s probably a good thing.

One common factor underpins both your objective and your understanding of risk: your time horizon. Without knowing your time horizon – and you’ll almost certainly have more than one time horizon at any given time – your understanding of risk will be missing a crucial dimension.

We have written an entire article on time horizon here. But before you jump into that article, see if you can answer the question posed in this post first: what does risk mean to you? Try and answer that without the dimension of time first. You’ll discover that risk is an emotive thing, and that it is unique to you. Then move on to the article on time horizon and turn that emotion into investment action.

We refer to lots of linked posts in this post. We hope that by following the links you can answer any questions you might have, but if anything is unclear in this post, or you have any questions relating to anything investment-related, please submit comments or questions in the section below and we’ll do our best to answer them.

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