On Defining Risk
Board: Macro Economics
As an individual investor and, then later as a professional advisor, I have wrestled with the definition of the word "risk" as it applies to one's investments.
In a recent comment on another thread, Wendy said (in part) the following: A portfolio can be less risky (that is, its beta can be reduced) IF the assets are not correlated.
Embedded in this comment are two of the main paradigms that seem to be the accepted Street wisdom on defining "risk": Beta and asset correlation.
I have a real problem with using Beta to define risk. Mainly, I guess, because I think more like an owner of an enterprise rather than as a trader of vehicles. As an owner of a business, it really doesn't matter much to me if Mr. Market is manic one day or week or month and depressive the next corresponding period. It might matter if I see either the manic or depressive influence take the price to the enterprise to levels of valuation where they are (by me) considered so absurd that I am almost forced to act (sell or buy more, depending).
The problem I have with correlation is several fold: first diversification of assets just so that I have money divided among supposedly uncorrelated (or lowly correlated) investment vehicles may be either brilliant or stupid depending on timing. Remember in 2008-9 all assets were proven to be correlated, so that should give some of the staunch asset allocators pause for thoughtful reflection as to the merits of the underlying thesis. So asset allocation leading up to that period may be considered of dubious merit.
If one is such that they do their own homework and are constantly on the prowl for mispriced opportunities, then asset diversification generally occurs over time and I tend to think of this type of diversification as more toward the smarter side of the allocation process.
However, if one doesn't know enough to do their own research, and depends on "professionals" to provide their allocation models, since 80% of "professionals under perform the benchmark index against which their performance is measured, I would consider this to be on the less smart side of the equation.
I have been participating in the board (with several periods of pulling away from the Fool altogether) for quite a few years. I do not remember having any detailed discussion of how we each and, perhaps, collectively define the last word of our boards name: "Risk".....does it have a different definition for individual portfolios than it does for macroeconomic trends? If so, should we state which definition or context we are using in any given thread?