Many people confuse risk with volatility. Volatility is not risk. It is like saying that the sea having waves is risky. If you build a ship and sell it saying ‘this ship will sail well when there are no waves’ – sounds like a joke, right?
This is so bad that ‘Risk adjusted return’ is return dividend by standard deviation. I can assure you that if you are not qualified as a CA, Actuary, Chartered Financial Analyst….this measure is completely useless. Rankings based on this is stupidity, and completely useless. Here I am trying to make it easy to understand risk….
Let us understand risk as a common man’s ‘worry’ :
1. Risk is NOT being able to meet ALL your financial GOALS: We have multiple goals – kids schooling, parents medical and other requirements, kids well being, our own living and some charities. It is fairly well documented that all goals do not happen at the same time…so it is possible that a person fulfills many of the goals and then dies in poverty or penury. THAT is risk.
2. Permanent Loss of Capital: If you bought Bharti Airtel at 289 and it went down to 253, and YOU believed it was TEMPORARY, it was NOT risk. And once the price went back to 289, the risk evaporated. Similarly if you have bought Reliance Industries at 1105 and it is now at 900, AND you believe that the price will come back beyond your cost, THERE is NO risk for you.
However if you have bought Jupiter Bioscience at Rs. 54 and it is now trading at 4, or Crest Animation was bought at 98, and is now trading at 22, or GMR bought at 71 and is now trading at 19. At to my unskilled eyes, IT LOOKS LIKE RISK. This is called a Permanent Loss of Capital. Thus investing in MDA is volatility, and investing in ADA is risk.
3. Choosing poor companies: And because of that underperforming the simple indices or good fund managers is again RISK of underperformance. If there is underperformance for long periods of time, you will live a sub optimal life in financial terms. However if you are anyway spending much much much lesser than your income allows you – this will hardly matter. I see many people with say Rs. 2 million in SB accounts – held aimlessly for 4-5 years. It does not matter to them.
4. Over reading, not understanding, ….that list is of course endless.
I hope this is simple enough. Charlie Munger also laughs at Risk = Volatility, but if you have done your MBA in Finance, I am sure you remember this shit that you were taught. CA s have a great advantage – what ever shit they know is at least self learnt 🙂
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