What does 'risk' mean?



From: Andrew Scott

"Risk = return"

"Failing to diversity is risky"

"Ignorance is risky"

Is there a technical definition of risk that explains why experts seem to have such different attitude to risk?

I am having trouble understanding the benefits or problems with diversifying, knowing what level of risk is present in different investments, and trying to determine what level of "risk" is good for me.

Andrew Scott
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Reply: 1
From: Keith J

Buy 'A Random Walk Down Wall Street' by Burton G. Malkiel and read the lot. Or pop into Dymocks and just read p229. The bottom line is that risk is variance from the mean. So a volatile investment is more risky, investments that give consistent returns are less risky.
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Reply: 2
From: Garry T

Abstract from the AS/NZS 4360:1999 Risk Management Standard describing the official definition of Risk.

the chance of something happening that will have an impact upon objectives. It is measured in terms of consequences and likelihood."

In practice it is generally likelihood x consequence where each is given a rating.

Reward is not taken into account when determining risk itself.

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Reply: 3
From: Neophyte .

If you're a reader then you could try a book called "Against the Gods: The remarkable story of risk" by Peter L Bernstein. This is a fascinating read. It includes how early insurance houses such as Lloyds of London started out, well as the benefits and costs of diversification.

Here's a short review of it:

It reads like a novel, but this new bestseller tells the true story of famous scientists and amateurs who actually discovered the concept of risk - of scientifically linking the present to the future. These pioneers equipped future generations with the instrument of risk management. Bernstein's engaging blend of biography, history, and science explains the development of risk management, along with related concepts such as probability, uncertainty, chance, and skill.
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Reply: 4
From: Andrew Scott

I was considering the idea that one should maintain a portfolio of properties that all have the same long-term return, but are affected by totally different factors. The portfolio should produce the same long-term return but with significantly less volatility / risk. Eg, unit in Melbourne, 4BR house in Brisbane, bungalow in California, parking space in New York, etc. (assuming that all have the same long-term return).

Thanks for all the suggestions. It seems I've got some reading to do before I'll feel happy with my understanding of risk.

Andrew Scott
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Reply: 4.1
From: Donna Larcos

That last comment is interesting because
it is exactly what Warren Buffett does with
shares. He basically looks for
companies that have consistent and
predictable returns as they pose the
lowest "risk". I went to a seminar a year
ago on his methods and apart from some
shares I had from floats which had mostly
done quite well, I purchased two stocks
based on his principles and, indeed, one
year later they have both returned in
excess of 20%, despite a falling market.
They have a history of predictable returns
based on 5-10 years of data and solid
management. There isn't the excitement
of the dot.com but these companies are
producing year in and year out, cycle in
and cycle out and generally above the
average return for companies. I just
bought my third stock on his principles in
January and two months later it has
returned 6% in a dividend and a special
dividend. Check out the Aspect Financial
site. It rates each share on the
stockmarket according to various "risk"
and "stability" factors. The STAEGR
search is particularly useful as is the
rating for earnings stability.
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