Often investment decisions are made purely on the basis of returns ignoring two other equally if not more important aspects – risk and time horizon. Risk, unfortunately is not easy to understand. Our industry including us have misrepresented risk by equating with volatility which as Christine Benz articulates in this Morning Star article, is a feature of equity investing. Instead, she talks about risk similar to what Kenneth French said in this article we featured last month “I define risk as uncertainty about lifetime consumption broadly defined.” In this article, Christine says:
“At times like these it’s worth remembering the difference between volatility and risk. At first blush the distinction seems like one of semantics, but it’s actually pretty meaningful. Volatility—periodic market downturns—is something we have to live with in order to earn strong long-term returns from stocks. Volatility becomes a risk if you need to be a seller in an environment when an asset class is down.
The good news is that you can manage both volatility and risk. The very best way to manage volatility is to ignore it. Turn off CNBC, go for a walk, read a book that has nothing to do with investing, or plan to make something new for dinner.
The best way to manage risk, on the other hand, is to maintain enough in safe assets to help ensure that you’re never a seller in a downdraft. Holding a complement of safe assets is particularly pressing if you’re retired and actively drawing upon your portfolio, and it’s the underpinning of the bucket approach that I often discuss. But de-risking is also important for younger people who have short- and intermediate-term non-retirement goals such as home purchases and renovations and college funding.”
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