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How We See It

Larry Quinn

Larry Quinn

February 16, 2012

What is Risk?
By: Larry Quinn, CPA and Branch Manager

Risk is all around us each and every day.  Some people consider driving a car risky while others don’t seem to mind driving but don’t like flying in an airplane.  Statistically you’re far more likely to die in a car than in an airplane.  Try telling that to someone who is afraid of flying.

Some people like risks (think racecar drivers, bungee jumpers) while others go to great lengths to avoid risk.

Risk is multidimensional with many factors interacting - like the athlete in top physical condition that suffers a fatal heart attack, possibly because of a family history of heart disease. 

Some risks are more apparent than others.  For instance, walking on a high wire is obviously a risk but on the other hand, the danger of being struck by lightning is not so obvious.

The bottom line is that you cannot live without taking some risks.  Since you cannot totally eliminate them, the best thing to do is try to manage them as much as possible. You do this in everyday life by evaluating the exposure and comparing the cost of partial exposure, transferring our exposure or avoiding exposure to the risk.  That’s why we stay away from people with colds, eat healthy diets, wear life jackets in a boat, or buy insurance.

Depending on your perspective, you could view risk as a negative (something to be avoided) or as an opportunity (look forward to the rush). Risk works the same way in the investment world.  Ask any group of people what risk means to them and you are likely to get some of these answers:

  • Danger
  • Possible loss
  • Uncertainty
  • Challenge
  • Potential gain

As in day-to-day life, risks are prevalent in the investment world, some more apparent than others.  There are many ways to reduce risk as it relates to investing.  Diligence in doing your homework, diversifying investment selections, and allowing for passage of time are some of the common methods of reducing some risk associated with investing.

It is important to understand there is an inverse relationship between risk and return.  When you invest, you plan to make money on that investment or, more accurately, earn a return.  In general, the higher the desired return, the greater the uncertainty about the end result; as a result, you are likely to have to take more risk to obtain it.  Think in terms of investing in a startup business with no proven track record.  Conversely, if you want a more certain outcome and lower risk, you may have to accept a lower potential return.  This time you might think about a FDIC insured Certificate of Deposit at your local bank.

There is a “risk-return tradeoff.”  You generally must trade off a higher potential return in exchange for a lower risk.  You can be assured if an investment offers the potential of a 12 percent annual return then there is more risk involved with it as opposed to the risks associated with an investment offering a potential 1% annual return.

With this simple piece of knowledge you will not have to know or recognize every single risk associated with investing to evaluate the ‘riskiness’ of an investment opportunity.  While this is too overly simplistic to base your investment decision, it at least provides a starting point for your own frame of reference.

In order to educate yourself about risks and return opportunities, you should seek out a trusted advisor to explain risks about various investments.  Then make sure you understand why you’re buying an investment and what role you want it to play as part of your investment portfolio.  In addition to making you a more informed investor, this also can help you gauge when to sell it.


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