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Investors Have Varied Definitions of Risk

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Risk plays a pivotal role in investing, yet a universal definition is elusive.

Merriam-Webster defines risk as:

  • the possibility of loss or injury
  • someone or something that creates or suggests a hazard
  • the chance of loss or the perils to the subject matter of an insurance contract; also the degree of probability of such loss
  • the chance that an investment (as a stock or commodity) will lose value

Investopedia defines investment risk as:

  • The chance that an investment’s actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviation indicates a high degree of risk.

In his upcoming book, Investing at Level3, AAII founder Dr. James Cloonan suggests a new definition of investment risk:

  • When the value of our investments—when it comes time to start drawing from them—is lower than what we would reasonably expect given our investment program.

As we have seen, the definition of risk, and specifically investment risk, is very broad.

Last week, we posed the question: “What is your own personal definition of investment risk?” In all, 188 readers responded and, as you would probably guess, we received a wide range of definitions.

Of all the definitions that we received, 27% dealt with the theme of losing money, loss of capital or buying an investment and seeing its value decline. To a much lesser extent (less than 4%), respondents attributed the unknown or uncertainty with investment risk.

Here is a sampling of the responses:

  • “An investment where the potential upside is either matched by the potential downside of the investment or the upside is significantly lower than other investment possibilities.”
  • “Any investment that doesn’t have a 100% chance of being successful. From there you take it down the ladder from very low risk to a very high chance of failing.”
  • “At what level of risk can I sleep well 100% of the time?”
  • “Buying something you do not know enough about.”
  • “Investment risk is in the eyes of the beholder. Investment risk for me is the risk that I will incur losses due to catalysts that are out of my control or ability to analyze, such as government policies (including arbitrary interest rate changes), environmental catastrophes, etc. Investment risk can also be seen as the risk that the purchasing power of your assets does not keep pace with inflation after taxes and investment expenses.”
  • “Money managers and I don’t agree. Many times what they call risk, I call volatility. Just because the sea is a bit rough doesn’t make it dangerous. A leaky boat on a smooth sea is very dangerous. If the fundamentals of a stock are bad, then I accept the normal definition of high risk. If the fundamentals are OK but the Beta is high, then I think “risk” is over-used–“volatile” is the better word.”
  • “Without risk, there would be no reason to own stocks. Even dividends are risky. A company can cut or stop them anytime. Risk must be managed. Risk is the amount you are willing to lose if an investment goes against you before you close the investment.”

Want to weigh in? Participate in our weekly member poll, updated every Tuesday, and see the results online at http://www.aaii.com/memberquestion.

For nearly 40 years, AAII has been providing unbiased, practical investor education to help individuals become effective managers of their own assets and achieve their financial goals. Consider a risk-free 30-day Trial AAII Membership today.

 

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