17 Dec “How I perceive risk” by a Golf Player.
Risks are everywhere in our lives. For some, risk is finally working up the courage to ask out the person that warms your heart, for others, risk is postponing their call to the garage to set up the appointment to change their winter tires, justifying that decision by saying that it’s unlikely that you will wake up to snow on a November morning. In finance, risk is a popular and important term, and everybody has their own definition. At Blue Bridge, risk is defined as the probability of a permanent loss of capital, whilst elsewhere, risk may be seen as the volatility of returns, notably in modern portfolio management theories inspired by Harry Markowitz’s. In the following text, I will elaborate investors’ relation with risk.
What is risk?
First, let’s define what risk really is. The Larousse dictionary defines risk as “the feat of committing an action that could provide an advantage but that also contains an element of danger.” Everyone defines risk in their own way, but everybody agrees that risk is difficult to evaluate and very complex to quantify. Investors often associate risk with the expected return of a stock or a strategy because returns are impossible to guarantee. In fact, in order to achieve expected returns, a certain level of risk must be taken and when risk is taken, loss is a possibility. So, it is possible to evaluate the risk of a strategy or a stock when you put it in relation to expected return. Investors can identify which strategy is more attractive by comparing them on a risk/return basis.
What is risk for me?
One of the first questions that we need to ask ourselves when it’s time to invest is: what degree of risk am I ready to assume? Usually, the answer to that question comes instinctively according to the investor’s personality and situation. Everybody is different and some people can support risk better than others. A lot of typical life situations can illustrate that relation, but as an avid golfer who already misses his sport and will be suffering through a long and rigorous winter, I will use golf to illustrate the risk/return relationship. Personally, I love to take risks on the golf course, but I will not risk a more aggressive shot or club selection without having previously assessed if the shot will potentially reward me for the risk taken.
Evaluate, ponder and take action (or not)
To properly analyze if the gamble is worth it, I will go through a process similar to that used by an investor in evaluating if investing in a stock or a strategy would be a smart choice. In fact, I try to assess my chances of success, what happens if I miss my shot and what the odds of various other results are. Once that evaluation is completed, I will go for the shot, but only if I judge that I will be properly rewarded for the risk that I am taking. If not, I will make a less aggressive selection … Well, most of the time! Obviously, I am biased in my evaluation because I have full confidence in my abilities as a golfer. In investments, that bias comes from the evaluation and understanding of the investor’s profile and his financial situation. For example, an investor will be more willing to take extra risk on an additional dollar of investment compared to the risk taken on the first dollar invested. Also, an investor will want to be more careful if the investment is to be used for his retirement or for his kids’ studies.
To conclude, it is important for an investor to clearly define his investment goals. An investor who wants to grow his fortune will have to take more risk than an investor who wants to protect it. The important thing when dealing with risk is to take well-educated decisions. So, in golf I make sure to evaluate how the ball sits in the grass and the wind direction before making my shot. In investments, it’s essential to consider the investors’ objectives and his time horizon.
 Expected return: Anticipated return by the investor for an investment in a given strategy.