Danny Dotson
Every investment will always come with risks. It is inevitable. Most people will categorize these risks as high or low risk. What is the difference between the two? And how do we classify them? Is risk quantifiable? We know we mentioned that risk is not uncommon, and it is present in every investment. However, we are also saying that risks have no exact meaning yet, let alone a way to measure them.
Risks and volatility
Since risk does not have accurate meaning and measurement, some academics thought that volatility could represent risk. It makes sense because it measures the variation of a given number in a time frame. The more the possibilities grow, the more they get worse. So, it is easier to measure. However, even if we consider what we just mentioned, it will never be a perfect replacement or substitute for risk because it does not impact those outcomes.
We can think of risk from another perspective. Let’s say that you expect at least a 20% return from your investment. The chances that the return will be lower is also the risk of your investment. Hence, the underperformance that comes hand in hand with an index is not the risk. We can think of risk as the chances of an asset or investment to experience a permanent loss of value or a performance lower than expected.
First, we have high-risk investments.
High-risk investments have massive chances for capital losses or underperformance. They pose high possibilities of devastating losses. But since we do not know how to measure risks precisely, labeling investments or assets as high risks might be subjective or intuitive. How? Let us cite some scenarios. For instance, if there is an investment that only has at least a 50% chance to gain the expected return, you might say that it is it “may be risky.” But if that investment turned out to only have a 10% chance to gain the expected return, anyone would agree that it is a risky decision to push through. However, while some people find the people who take high risks foolish, some find those who do not take them as foolish. They say those terrible outcomes are inevitable. Thus investors must consider their magnitude and likelihood.
Next, we have low-risk investments.
Investments with low risk have considerably lesser things at stake. There is lesser to lose when it comes to the investment amount or its significance to the portfolio. Hence, there is also lesser to gain when it comes to returns and benefits in the long run. These investments are for risk-averse investors because there is a sense of protection from any loss. If there were losses, they would not be as devastating compared to the high-risk investments.
What can we say?
We say that there is nothing that can accurately define or measure risks. But suppose investors look at risks in a way that is characterized by a capital loss or underperformance related to expectations. In that case, it will be easier to define and measure low- and high-risk investments.
