Forum Post: What is Investment Risk ?
Posted 13 years ago on Nov. 14, 2011, 7:23 p.m. EST by FriendlyObserver
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how is this calculated?
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The inability to predict the future.
Investment Risk is usually associated with the volatility of the security and can be affected by how it's leveraged(whether by using borrowed money or using securities like derivatives and options).
It's usually estimated using the standard deviation of historical returns. If you're only investing in stocks, a rule of thumb would be that large stocks (AT&T, Alcoa, etc.) have very low risk, but also have low potential for high returns. Smaller stocks tend to move much faster than the market on average.
I know it's a clustered explanation, but the notion of "investment risk" is better suited for an entire chapter of an introductory business text.
can risk be avoided?
It can be avoided, but at the expense of overall return in the long-run. This usually go against our intuitions that risk-aversion is absolutely positive and making risky investments is just a bad trait.
The most risk-averse investment are US Treasuries. In business, the interest rates are theoretically called the "Risk free rate of return". That's based on the assumption that US would never default on its treasuries. These treasuries are basically bidded on when the treasury sells its bonds and are frequently sold between organizations. The rate for multiple time-spans are watched closely by investors. You can find them here.
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
The rates in the current business climate are way too small to make it a good investment for many current economic reasons.
You could also invest in CDs(certificates of deposit) because they have a slightly higher yield, but they also tend to follow the return of treasuries.
The other ways to avoid risk is either by using other securities(like stock options and derivatives) which are complex or by investing in multiple stocks that are risky, thereby diversifying your risk.
The rule of thumb when it comes to 401k investments is that the longer your expected working life, the more risky your investment choices should be. I have almost all mine in diversified international investments(riskiest of my choices) because I'm still in my 20s.
I was just told there are no " non risk " investments . Is this true?
That is definitely true.
A "non risk" investment or "Risk Free Rate of Return" is almost like a perfect circle. It doesn't exist in the real world. So when investors refer to it, they just use the US Treasury Yields as their way of approximating it, instead of arguing about what the philosophical notion of "certainty" really means.
If you are big enough, the government will bail you out.
thats always nice ..
Unless you are the one doing the bailing ...
I would be the one taking the risk ... I think
There is no risk to corporate investors, as they have hedges around hedges, it is a friggin' hedge maze around any risk! If they lose on an investment/gamble they transfer that investment to their retirement fund investors. This is how the table it tilted and the game is rigged, the big players never lose, they only shift risk and loses to your mothers account, and they take a fee on the front and back end for the effort!
SlowMoney.org
Invest in your own community yourself! Don't play in a rigged casino!!
it can be calculated in alot of ways. its fairly vague. but a good rule of thumb, the riskier the investment, the greater the returns. but not always true.
why does risk effect returns?
It doesn't "effect returns" really. It's really just a tradeoff. The actual prices of stocks are based on how much people are willing to pay for them at any point in time based on the speculated returns. The more certainty that stock can offer, the more people you have clamoring for that stock. So, basically, we're all bidding on stocks based on the speculative return. The more uncertainty surrounding the stock, the less people are willing to participate in the bidding process for it, and so there is a slight disparity in return between risky stocks and risk-averse stocks.
Risk is priced into investments. That's why risky businesses trade at a discount. The bigger the risk, typically equates to a bigger potential gain. There are no non risk "investments", there are low risk asset classes that are very secure, but have very small returns on average. Think of housing, people used to say it was the best investment, then we had years of 8-30% gains. When you saw markets returning those monster gains, they became the biggest risks (the areas hit hardest on housing depreciation, were for the most part the areas with the biggest gains in the preceding 5 years). There are at least a half dozen risk calculations that are widely accepted, different types of investors use their own model. This is what you used to get from your stock broker.
how much does risk cost?
It's variable. Like insurance. Your insurance is higher based on probability that you will crash your car. As you become less of a risk, your rate goes down. If you wreck, mathematically you are more likely to wreck in the future, and it goes up. Models vary, but in a free market, risk costs whatever people will pay for it.
can you buy risk insurance?
All insurance is risk insurance. But, I think if you are asking if the risk can be mitigated. The short answer is yes, that's what hedging and diversification are.
It's an art more than anything. How much of a risk do YOU think you're taking. Besides, it's all relative. If I'm only investing 5% of my money, it's going to be a much smaller risk for me than if I'm investing 50% of my money into one thing.
an art? like ..creative risk ?
Well that depends on how creative you get with it. Think of it as an educated guess. You will have hard numbers to back your decision, but a lot of it is art.
I would like to see the picture !
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By dividing the probability of someone like Bernie Madoff getting your money by the amount of your investment, minus the chances of your investment firm going under times your chances of being audited by the IRS divided by the square root of 3.14.
sounds complicated .. do we equate risk with circumference