What is Risk?

April 17, 2015

The following is a recent quote by Warren Buffet from a meeting he had with MBA students just last February.  When Buffet speaks, I listen.  He provides his definition of risk with respect to stocks.

“With regards to risk, the Berkshire portfolio suffered a 2% loss once and had 1% losses twice in our history. This was all in 1974 and 1975 when we sold assets cheap to buy other assets cheaper. Stocks are riskless if held over a long time frame as you are simply giving up purchasing power now for later. Cash is the risky asset. Risk in stocks is not what the companies will do. Traditional finance teaches that Beta is a measure of risk but volatility isn’t risk. Risk is loss of purchasing power. Volatility declines over a long enough timeframe. It is individuals that make investments risky. In our report that is due out tomorrow I talk about how risk needs to be rethought. People think stocks are riskier than bonds, which is not true for a long time horizon.”   Warren Buffet

The best investments in the world can provide terrible returns if the investor doesn’t know what he/she is doing.  Here’s the definition of risk I like, which applies to doing anything in life:

Risk is not knowing what you’re doing!