Low-Risk vs. High-Risk Investments: What's the Difference?

Introduction

• Risk is fundamental to investing, influencing returns and performance.
• New investors often struggle to identify and measure risk.
• No consensus on definition or measurement of risk.

Understanding Risk

• Academics use volatility as a proxy for risk, but it's flawed.
• Better view: risk as the probability of a permanent loss of value or underperformance.
• Key takeaway: focus on odds of investment failing to achieve expected return.

High-Risk Investments

• Characterized by a high chance of loss or underperformance.
• Investors should consider both likelihood and magnitude of bad outcomes.
• Example: Biotechnology stocks have a high risk due to experimental failures.

Low-Risk Investments

• Involves less at stake and less potential gain.
• Focus on minimizing the chance and impact of losses.
• Example: U.S. Treasury bonds have minimal risk of failing to deliver expected returns.

Examples

• Biotechnology Stocks: High percentage chance of underperformance.
• U.S. Treasury Bonds: Very low risk, secure principal and interest payments.

Special Considerations

• Diversification reduces risk and potential losses.
• Important to analyze risk from various angles including diversification, time horizon, and expectations.
• Risk of holding a concentrated portfolio vs. a diversified one.

Conclusion

• Risk and return are correlated; higher expected returns come with higher risk.
• Investors need to understand their risk tolerance and make informed decisions.
• Consider factors like diversification, time horizon, and knowledge when assessing investments.