Risk is slippery, risk is nuanced. Most folks forget the negative side of risk, instead remembering the old saw, ‘the more risk you take, the more return you earn’. Here are some situations that can fool the mind:
- You buy a start up biotechnology company with no earnings and as yet, no product. It goes up 100% in a year. Is this risky? Yes. In this case, the risk paid off in the short term, but you could just have easily lost all your money.
- You buy an early stage technology company with some earnings and two products. It sinks 90% in a year and then goes out of business. Is this risky? Yes. In this case, you took risk, and the portion of the adage above that is never quoted – ‘over time’ – raised its ugly head. You need several risky transactions in a diverse portfolio and a lot of time for that adage to work out. Between first investment and realizing a high return, you will put up with a lot of volatility and some disasters.
- You go in with your brother to build two spec homes in Boulder, CO. It is 2007 and homes in Boulder have gone up a lot in price. Is this risky? Yes, and you are about to lose a lot of money. You will have to wait until at least 2015 to regain most of your investment. If you have to sell before then, you lose money.
- You are one year from retirement and you have 90% of your funds in stocks. You need to live off your portfolio when you retire. None of your stocks pay dividends, but you do have 10% of your assets in bonds. Is this risky? It depends. If you have enough money and can adjust your budget to big market downdrafts, it is not as risky as if you need a fully reliable draw that is on the high side relative to your portfolio size. It IS risky, because you are betting on an unreliable phenomenon – appreciation – to pay your way. But how risky it is, is situational.
- Oil prices are down 66%. Exxon is trading 30% below its 52 week high, at its low for the year. You decide to buy Exxon stock. Is this risky?
The answer to the last scenario is where nuance arises. Exxon didn’t look risky when oil was at $110 a barrel and the stock was at $100 a share. Now, with oil at $37 a barrel and the stock at a 52-week low, it looks risky. But: is it? Stay tuned for Part III.