”Risk is loss of purchasing power.”- Warren Buffett
— D.Muthukrishnan (@dmuthuk) May 4, 2017
Very interesting tweet to start for.
— CFA Institute® (@CFAinstitute) April 30, 2017
…and I am agree.
So what is risk?
As per Investopedia, Risk is possibility of not getting what you invested. In general language, risk is anything what you get different from what you expected. So if you accept this definition, Risk equal loss may look right. But risk is not one thing. Its combination of many different type of risks depending what you are doing. If you are investing in Government securities, risk profile here is different. But if you are driving car then your risk is different. If you are Farmer then for you, different seasons holding different risks.
In investing every, asset class holding different risk profile. Like Equity is different, fixed income is different. In equity, value stocks are different then growth stocks. Emerging market holds different risks then developed market. Asset back securities holding different then Govt securities.
Most basic rule in investing is Higher the risk, higher the return.
You can’t get return with zero risk. Even with Govt securities there is risk attached that is inflation risk and interest rate risk. That’s why you received SOME return over it. Another myth here is Bonds are risk Free. No. The question is who is issuer, Coupon, maturity etc of bond decided what is risk profile.
There are ways to reduce risk. You can transfer the risk through Derivative. You can reduce the risk. You can avoid the risk.
On the other hand, loss means Failure to keep something or to have something. Complete absence. there is a term in finance called value at risk. I believe that this concept explain difference between risk and loss.
Value at risk is a measure of risk of investments. it measure how much set of investments might loss given normal market condition in set time period such as day, year, month etc.
Lets take an example of Farming.
There are many risk for crop. Farmer might not get return what he expect. someone may steal crop. it maybe burn. there maybe infection. But still there is no loss. There is risk of loss. A farmer can reduce risk by many ways like use of Pesticides, derivatives, Crop insurance, by keeping watch on it. But still there is risk. WHAT IF BUYER DONT HAVE AMOUNT TO PAY?Going to end this post with one quote of Warren Buffett
Risk comes from Not knowing what you are doing.
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