3 Aspects of Risk

Destruction, volatility, and uncertainty.

John Rekenthaler 09 December, 2013 | 18:15
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Destruction
One of my previous column’s highlighted one aspect of risk: the possibility that an asset becomes destroyed (either fully, such as by a government confiscating assets, or partially, as in a large inflation-adjusted loss sustained over multiple decades). The source was Bill Bernstein, who listed "four horsemen" of destruction: hyperinflation, severe deflation, government confiscation, and war/devastation. To Bernstein, an investment adult is one who worries less about monthly fluctuations and more about avoiding catastrophes. 

Bernstein is hardly the first to separate long- and short-term considerations. Many have distinguished between "risk," meaning the former, and "volatility," meaning the latter. Indeed, such an argument was commonly made by motivational speakers in the U.S. during the 1990s, who urged financial advisors to keep the faith with equities and to keep putting their clients into stock funds.

I recall such a presentation in 1997: A gentleman named Nick Murray held up a 3-cent postage stamp to a crowd of financial advisors. He then asked them a stamp's current cost. Forget researching investments and building fancy strategies, said Murray. Just show clients the 3-cent stamp and get them into stocks. When the clients called in the future, worried because stocks were declining, show them the stamp again. While he didn't phrase the matter in that way, effectively Murray told his listeners to worry more about the first of Bernstein's four horsemen, (hyper)inflation, and less about monthly fluctuations. 

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John Rekenthaler  is vice president of research for Morningstar.

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