Your money and risk

Much of what you have been taught has been incorrect; especially the notion and definition of risk in the business field.

What do you think is risk? A higher risk level means higher reward and lower risk means lower reward?

In investing, treasury bonds are categorized or considered as "risk-free" securities because they possess low levels or nearly zero variability.

So how should we see risk? We should see it as the ultimate outcome; in other words, the probability of a complete loss or injury. We should not correlate risk with return. Academically, in finance, a denotation of this term is named BETA.

BETA measures how risky an investment can be. The higher the BETA, the higher the risk, and vice-versa. The notion behind this should explain that to have higher return, we should look for investments with high BETAs, and if we are looking for safety, we should always consider the low BETA investments.

This is erroneous, there is no argument that states that investments with certain levels of BETA outperform others based on this number, nor, identical BETAs that provide the same level of returns.

Then, how should we consider risk in an investment?

Risk needs to be seen as the probability of the certitude of an outcome. How sure can you be of this outcome in the future.

An example of how to measure risk, properly quoting Warren Buffett,:

"Make sure that you don’t drive a truck that weighs 9,900 pounds across a bridge that says 'Limit 10,000 pounds' because you can’t be that sure. If you see something like that, go a little further down the road and find one that says, 'Limit 20,000 pounds.' That’s one you drive across."

See, there is no need to be precise on your analysis of risk, but make sure there is enough margin of safety to cross your cargo over the bridge.

So how do we view risk?

In Wall Street, it is assumed that to make money, you need to take higher risks.

At Sonoman Investments, we analyze risk and invest where we have a higher probability of success.

Written by:
Alex Lopez
Posted on:
July 31, 2017