Investment
professionals love complicating things.
Trust me
on that. I was once like that.
You
don’t believe me?
The next
time you meet people from the investment industry, try asking them to give you
a definition of the word “risk”.
Investopedia defines “risk” as “the
chance that an investment’s actual return will
be different than expected...risk is usually measured by the standard
deviation of the historical/average return of a specific investment.”
Don’t get me wrong. This is actually a pretty good definition of "risk”... that
is if you speak finance. But most
people don’t, and if you are like most people, you probably struggled to
understand even the first sentence (actual return vs expected
return...huh?). Good luck attempting to measure risk!
Then, what does RISK mean?
The
problem is, people don’t normally think of risk that way. An investment
that is “uncertain” or “volatile” may not necessarily be risky. Let me give you an example;
Suppose
there is no chance of losing money on this particular investment, but
depending on a certain factor (e.g. how the weather turns out to be in a year’s
time), you could either make a small profit or quadruple your money,
or anywhere in between. We both
know that if such an investment exists, it is a no brainer – this investment
has no risk (you either win small or win BIG)!
But by
definition, this investment is highly
risky! Why? The outcome is highly uncertain: you could make a small profit (say +1%) or
any amount up to quadrupling your money (+300%)! Isn’t it
absurd that professionals define this as a highly
risky investment?
This is how I think “risk” should be defined: The
potential for losses.
That’s
it!
Therefore,
a risky investment has a high potential for losses. An
example: a share of a single, unproven company in a politically and
economically unstable country. A not
risky investment has a low
potential for losses – like a bank account.
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This guest post was written by Ching, the founder of iMoney.my, a price comparison website for Malaysians. Ching is a CFA charter holder, and was formerly an investment consultant and wealth advisor.
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