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Author: markbyouk Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 297  
Subject: Re: Is Risk the same as Volatility? Date: 4/5/2000 7:46 PM
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I have been following the thread here on risk, and I would like to propose my concept of risk for your consideration.

Essentially risk is about uncertainty. If you are certain (know everything) about a particular outcome, then there is no risk. On the other hand, if you are like most people that don't know everything (whether you admit it or not) then life is full of risks. Indeed, life is about the management of risk, not its elimination.

Is volatility risk? Yes. The movement in the price of an asset creates uncertainty, therefore risk in the ultimate value of the asset on any given day. But, is risk embodied by volatility? No. Volatility is simply an element of risk.

Is leverage risky? Yes. The use of leverage magnifies returns - both positive and negative. The magnification of a potential negative outcome certainly creates an element of risk.

Is risk quantifiable? My opinion is no. You can "certainly" generate a number of statistics that attempt to measure risk - alpha, beta, gamma, etc. - but you can't measure risk with "certainty". Further, it is my opinion that risk is a relative concept, and at the end of the day, it is the individual that defines risk - in the context of his particular situation.

Warren Buffett has said that you concentrate to create wealth, you diversify to protect wealth. Obviously, Warren feels that diversification mitigates risk. The great thing about a well thought out investment plan that is properly diversified, is that over time it can BOTH mitigate risk and increase wealth.

The important thing here is to understand diversification and its impact on the risk you are willing to take regarding investments. The primary factor impacting your investment returns will be your choice of asset classes. Historically, returns have significantly increased as you moved up the food chain from money market instruments, to bonds, and ultimately stocks. If an investor makes the mistake of defining risk solely in the context of volatility - the choice is money market funds - even though historically, stocks have proven to be the superior investment.

Thus, in my opinion, diversification within the proper asset class (stocks) is much more important to the long term investor than diversification among asset classes. How do you know when you have properly diversified your investments? When you understand everything that you have invested in, and can sleep at night without worrying about the day-to-day machinations of the market.

My thoughts on the subject.

Regards,

Mark



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