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Post #7 Volatility is NOT risk
Gaurav Singh
October 13, 2022
Investing, at its core, is foregoing consumption today in anticipation to have ability to consume more in the future. An investment always involves the expenditure of some resource today - time, effort, money - in the anticipation of greater purchasing power than the initial investment. The expense today is the sacrifice and the return afterwards is the reward.
What is risk
Risk, as understood from the above definition: is the chance that an investment causes its owner a loss of purchasing power over the duration of the investment. Risk is the chance that one does not get the rewards even after the sacrifice.
Everything we have discussed so far is just common sense. But common sense is not taught - is it? The meaning of risk as taught in business schools and as propagated by finance professionals is something completely different.
What is taught
To academia and finance professionals, an asset that is volatile i.e. fluctuates a lot in its price is a riskier asset. Volatility, the great standard deviation, with its cousins: risk free rate, market premium, correlations, efficient frontiers - all try to fit giant complexity of financial world into neat little equations. And, common sense is forgotten.
The words risk and volatility have been made so synonymous that an investor who should avoid risk now avoids volatility. This is the reason you will see trillions of dollars invested in "less volatile" debt instruments which over the long term make no difference to the purchasing power of their owners.
This great emphasis on volatility in corporate finance we regard as nonsense. Let me put it this way; as long as the odds are in our favour and we’re not risking the whole company on one throw of the dice or anything close to it, we don’t mind volatility in results.
The Bottom Line
An investor should learn to question worldly "narratives" and apply rational independent thinking at all times.
To an investor, risk is the probability of loss of purchasing power due to the investment.
Volatility has got nothing to do with risk.
Mistaking volatility for risk could be injurious to the financial health of an investor.
That's all for today, have a great day ❤️