Risk = ??

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?

If Risk = Standard Deviation, then

Poll ended at 05 Sep 2005 11:48

Risk is a probability of a loss
2
11%
Risk is a measure of uncertainty
12
63%
None of the above
5
26%
 
Total votes: 19

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Shakespeare
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Re: Risk = ??

Post by Shakespeare »

Who wants to eat premium streak every day?
Me. :mrgreen:
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Re: Risk = ??

Post by NormR »

Shakespeare wrote:
Who wants to eat premium steak every day?
Me. :mrgreen:
Try it for a month or two and let us know how it worked out. :)
Last edited by NormR on 16 Mar 2014 23:10, edited 1 time in total.
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Re: Risk = ??

Post by Shakespeare »

Send me a cheque or a gift certificate and I'll be glad to oblige. :thumbsup: :wink:
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Re: Risk = ??

Post by parvus »

Norbert Schlenker wrote:
parvus wrote:I'm not sure a cookie-cutter 40% bonds, 60% equities portfolio works, whether it's ETFs or some other investments that can be comparable to a recognized benchmark... and accumulate enough to have the same level of consumption in their retirement: i.e., income smoothing. Nice theory. Got the Nobel Prize. Not sure it actually describes (nor actuates) people's real behaviour.

Investing, depending on risk tolerance, may not be the best way to achieve income/consumption smoothing...

From a lifecycle perspective, I would suggest just buy the market and forget about it. If it underperforms your wages, oh well. If it outperforms, bonus!
This seems a bit of a ramble, at the end of which you suggest the conventional wisdom anyway.
Yes, it was a bit of a ramble. There are three thoughts animating it: my Depression-era friend's risk aversion; the standard or "policy portfolio;" and my own deviation from norms.

1) My Depression-era friend doesn't understand why I don't just invest in bonds like her. She hates losing money, period, because her father gambled the family money away.

I fully understand that perspective, even though I don't share it. She was unimpressed that for every $1 I've lost investing I've been paid $7. She focuses on the loss and asks me why I do it. I say, because I need the money. While I'm fairly frugal, I don't have a paid-off house, so my income needs in retirement will be higher. She can live off a $200,000 bond portfolio paying 10% plus OAS, plus a successor pension. So could I. But I have none of those things.

So we clearly have different views on risk.

Hers would best be encompassed by Zvi Bodie's approach: immunize 90% to 95% of your liabilities with bonds. That would however require very high savings rates, which I suspect the vast majority of Canadians cannot attain.

2) The "policy portfolio" is an attempt to compensate for that lack of savings. I, perhaps somewhat untidily, transferred a pension debate into a retail setting, by referring to the ETF/index contingent. And I also, perhaps, rambled my way out of that one, lest I be considered dogmatically anti-indexing. I'm not.

But for me, it's the most convenient touchstone. People here think of the cheapest possible access to an asset class. In the pension world, it's all about tracking error. But those issues are secondary to the more pressing question, why are you investing at all?

As ghariton notes, there may be an opportunity cost to not investing, at least at the corporate level. And if people have free cash flow, why not invest?

But do most people have free cash flow?

There are different ways to approach the question. For a corporation, investing may lower the balance-sheet burden of funding a pension obligation upfront. For the workers, their pensions may be sufficient to provide ... hence the limited RRSP room they have.

That seems to me to be an opportunity-cost argument, namely that you'll get better risk-adjusted returns through stocks.

That addresses free cash flow, of course.

But not risk, or risk-adjusted returns, or even the source of risk. For example, OTPP has had stellar returns, but the plan is slightly underfunded, and has made inflation-indexing contingent. I put that down to a combination of things: labour unrest risk, early retirement risk and not finally equity risk.

OTPP has to navigate through all three (and perhaps others that come to mind).

On the basis of what? Retrospective asset class returns. But that's the best data we have. I'm not sure here that many people buy prospective earnings forecasts.

So the risk is actually unknown.

3) Which leads me to my own deviant behaviour. Because I was rebalancing, I took a gander (well, actually a couple of weeks) sorting through the GlobeFund data for various asset classes. One reason was because I had cash sitting undeployed in the account for about a year, after my bet on the TMX takeover (which worked out well for me, I bought at $45 and was taken out at $50).

I do tend to procrastinate, so I wouldn't be a very good swing-trader. I was looking for another stock, preferably a good-quality dividend-payer trading at a 52-week low.

At the same time, I looked over my fund holdings, to see what had performed over the past three years.

By the very fact that I bet on the TMX takeover (and before that, the BCE takeover) I recognized that I had more of the gambler personality associated with CAPM. My utility curve is different from the average GIC or bond investor. Yet, I trade very rarely.

That seems a bit contradictory, I think. On the one hand, I seek out deals; on the other hand, I tend to buy and hold. So where do I stand on the risk spectrum?

I'm not like my Depression-era friend, absolutely risk averse. I'm not like the "policy portfolio" folks who maintain a constant asset allocation through rebalancing. I'm not concerned about the cost-price tradeoff (though I wouldn't slight it either).

Some of this thinking was provoked by a meeting with a fee-only planner who specializes in ETFs, who suggested I dump all my legacy mutual funds. It took me a couple of weeks to determine that, for the most part, the legacy funds outperformed the comparable ETFs. (Of course, I still have some small allocation to labour funds that now all seem to be in receivership -- but thankfully they were never more than 3% of the portfolio.)

I was surprised.

So I've been tidying up the portfolio, but along the way recognizing that cost is a risk factor too. Indexing minimizes that cost, naturally, but it might raise the opportunity cost. I've done very well, for example, by Mawer and Chou. With both, I've assumed cost risk, tracking risk and concentration risk.

But another way to describe my peculiar risk tolerance is that I have no bond investments. I do have high-yield bonds, but not for income. They are instead a play on capital structure or, globally, on interest rate cycles.
I can't tell if you think the income smoothing goal is right, or even right just for you. You seem to have put a lot of thought into it and, when push comes to shove, gone with "Whatever!".
I think it's an all-too clever theoretical approach that doesn't describe actual behaviour. However, as a prescriptive approach, it has some merit. It begins with savings; investing is an add-on.
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Re: Risk = ??

Post by parvus »

NormR wrote:
Shakespeare wrote:
Who wants to eat premium streak every day?
Me. :mrgreen:
Try it for a month or two and let us know how it worked out. :)
Can't you get premium streak from your local graffiti artist? Might even become a Banksy.
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Re: Risk = ??

Post by Norbert Schlenker »

I'm pretty sure Shakes wants this instead:

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Re: Risk = ??

Post by Shakespeare »

I see Norm was too, er, r'sy.

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Re: Risk = ??

Post by ghariton »

What are you guys on about, the risk of a heart attack?

Talk about thread drift.

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Re: Risk = ??

Post by parvus »

That's always a risk.
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Re: Risk = ??

Post by Shakespeare »

ghariton wrote:What are you guys on about, the risk of a heart attack?

Talk about thread drift.

George
I see that Norm has uncovered his r's. :wink:
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Re: Risk = ??

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Shakespeare wrote:
ghariton wrote:What are you guys on about, the risk of a heart attack?

Talk about thread drift.

George
I see that Norm has uncovered his r's. :wink:
It's a Risk.
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Re: Risk = ??

Post by CROCKD »

From The Wall Street Journal
Finances and the Aging Brain:
The latest research on why even smart investors fall prey to financial predators

Some recent research has shown that highly intelligent retirees—even those with no signs of dementia—find it harder to distinguish safe investments from risky ones.
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Re: Actual US Volatility example

Post by kcowan »

One of the members of the Early-Retirement Board, posted the following which I thought was instructive:
Volatility
I went through my records to see how many times I've experienced a drop of ~20% or more. I've been keeping track since March 1998. Now, none of these were overnight drops, but were still some pretty rapid wipeouts. Also, they represent drops in total values, so by the time you work in additional assets, the actual percentage was probably worse. Anyway, here goes...

1) December 2000 to March 2001: -20%
2) June 2001 to September 21, 2001: -26.6%
3) March 2002 to July 2002: -24.3%
4) August 11, 2008 to November 20, 2008: -44.2%
5) January 6, 2009 to March 9, 2009, -19.6% (okay, not 20%, but darn close!)
...
As for lesser, ~10% drops, haven't had one of those in awhile. They used to seem somewhat common before the Great Recession. Looking back, these pop out at me...
1) March 2000 to April 2000 (but recovered by June)
2) June 2004 to August 2004 (recovered by October)
3) May 2006 to June 2006 (recovered by September: This one "hurt" pretty bad though, because by this time I had a lot more invested, so it was a ~$30,000 loss)
4) July 2007 to August 2007 (recovered by September)
5) 12/31/07 to January 2008 (recovered by February)
6) 6/23/08 to 7/8/08 (9.5% loss, recovered by 8/11, and then the big plunge into the Great Recession started)
Obviously this would be influenced by portfolio composition and any active rebalancing strategy.
Last edited by kcowan on 21 Jun 2014 12:51, edited 1 time in total.
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Re: Risk = ??

Post by Shakespeare »

I keep track of running month-end 12-month total portfolio changes (expenses are included as Equation 4 in Appendix:  Compound Interest Formulae and Weighted Returns ).

The largest 12-month drop was -15.2% in the 12 months ending Feb. 2009.

The largest 12-month return was +30.2% in the 12 months ending Feb. 2010.
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Re: Risk = ??

Post by ghariton »

I retired at the start of 1999, so I followed my portfolio rather closely for a while. Eventually I lost some two thirds from May 2000 to the end of 2001. There was quite a bit of volatility. I remember being up 10% in one day. A few weeks later, I was down 17% in two consecutive days. And remember, this was the money I was supposed to live off, for the rest of my life.

That experi4ence led me to believe that volatility is indeed a pretty good measure of a certain kind of risk. (There are other dimensions to risk, of course.)

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Re: Risk = ??

Post by deaddog »

My story is the same although I was only down about 50%. Retired right at the top, mid 2000 and watched my net worth plummet. I had no idea what to do, so I did nothing. Ostrich approach; I stuck my head in the sand and hoped the danger would go away. Luckily for me it did. It scared me and changed the way I looked at the markets.

I knew that I didn’t want to go through that scenario again. My focus changed from achieving maximum returns to protecting my capital. From giving control of my investments to someone else to taking full responsibility for the outcome. From fundamental analysis to Technical. From having no idea what my risks were to defining the risks I was taking and accepting that risk.

It is fine to have a measure of risk, volatility or whatever metric you want. The question still remains how do you control it?
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Re: Risk = ??

Post by ghariton »

deaddog wrote: From having no idea what my risks were to defining the risks I was taking and accepting that risk.
Yes indeed.

There is nothing like living through one of those episodes so as to learn both what risk is, and what one's tolerance to risk might be.

That's why I'm sceptical of the usual broker's "know your client" process and in particular the determination of the client's risk tolerance.

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Re: Risk = ??

Post by BRIAN5000 »

From Larry Swedroe posted elsewhere

Assume you begin with a portfolio that is $600,000 in stocks and $400,000 in bonds. Now assume the stock market loses 50 percent and bonds have increased 12.5 percent. Thus, the portfolio is now at $750,000, with $300,000 (40 percent) in stocks and $450,000 (60 percent) in bonds. And now it’s time to rebalance.
To restore your portfolio to your target of 60 percent stocks/40 percent bonds you’re going to have to buy $150,000 of stocks (that have just lost 50 percent and some guru is forecasting it will drop another 50 percent) and sell $150,000 of your safe bonds that actually have risen in value. Will you actually be able to rebalance? My experience is that investors become more conservative when asked the question with dollars as compared to when they’re asked in percentages. Which is why given the importance of the question, the question should be asked in dollars. Otherwise, you’re likely to be overconfident of your abilities. Framing questions in the right way is one way a good financial advisor can add value.

This gets even worse on larger portfolios, even ones with low equity alocations, would you actually have the liquity in your fixed income side to be able to rebalance?
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Re: Risk = ??

Post by deaddog »

ghariton wrote: Yes indeed.

There is nothing like living through one of those episodes so as to learn both what risk is, and what one's tolerance to risk might be.

That's why I'm sceptical of the usual broker's "know your client" process and in particular the determination of the client's risk tolerance.

George
It was more the feeling of helplessness that got to me. To sit and watch your nest egg disappear before your eyes week after week and not knowing what to do about it was very frustrating.

I was afraid to get out and I’m still not sure why. Aversion to taking a loss; Afraid it would go up; Fear of being wrong; and probably a couple others I’m not aware of all seemed to be stronger than my fear of losing money. At any rate my strategy of “Ignore it and it will go away” worked.

I then started asking brokers and financial advisors “How do you manage risk?” I never found one that gave me a satisfactory answer. The usual answer was hold on and hope. My next question “Will you rebate my fees if the investment loses money?” usually ended the interview and got me shown the door.


I don’t think most people know their own risk tolerance, so how can they explain it to a broker or financial planner?
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Re: Risk = ??

Post by AltaRed »

Brian, I read that article and found it interesting. IIRC, that is the position you have taken when debating the issue....while I have taken the opposite view, i.e. percentages. I think it ultimately depends on the degree of investor knowledge and sophistication, e.g. the average investor with a full service advisor probably needs to be asked the question that way to put it in context. I'd suggest the experienced investor, e.g. one with 10-20 years of investing experience, intuitively can 'feel' it both ways.. .and probably uses both measures.
This gets even worse on larger portfolios, even ones with low equity alocations, would you actually have the liquity in your fixed income side to be able to rebalance?
I would imagine so. The larger portfolio would (should) have a fairly large helping of bonds in the FI portion. Those are rather liquid.
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Re: Risk = ??

Post by BRIAN5000 »

IIRC, that is the position you have taken when debating the issue....while I have taken the opposite view, i.e. percentages
Yeah I new if I looked long and hard enough I'd find someone that would agree with me, at least partially, so now theres two of us. :roll:

I have no bonds only cash & Gic's so I need to look at this a little closer.
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Re: Risk = ??

Post by AltaRed »

BRIAN5000 wrote:I have no bonds only cash & Gic's so I need to look at this a little closer.
We should probably take this to a different thread... but suffice to say I am surprised. I believe you have a fairly large portfolio and would have thought you'd have some longer term bonds in your registered accounts, e.g. provincial/crown corp strips, RRBs, and/or medium term corporates....and hold to maturity.

Added: Your GIC ladder would certainly provide the annual/semi-annual liquidity for re-balancing.
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Re: Risk = ??

Post by like_to_retire »

AltaRed wrote:would have thought you'd have some longer term bonds in your registered accounts, e.g. provincial/crown corp strips, RRBs, and/or medium term corporates....and hold to maturity.
Myself, I use preferred shares instead of bonds to flesh out the terms longer than 5 years that GIC's provide. There just isn't the jump in yield after 5 years in bonds. Preferreds offer those better yields.

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Re: Risk = ??

Post by AltaRed »

Yeah, but this thread is about risk and prefs don't really cut it as a counterbalance to equities. I see them as a 'third leg' unique space in the AA pie.
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Re: Risk = ??

Post by parvus »

ghariton wrote:
deaddog wrote: From having no idea what my risks were to defining the risks I was taking and accepting that risk.
Yes indeed.

There is nothing like living through one of those episodes so as to learn both what risk is, and what one's tolerance to risk might be.
I dunno. I have no life insurance. Yesterday an RBC rep called me to sell not life, but AD&D. I said I have no dependents, no other financial obligations, and enough money to pay for my own funeral. He quickly ended the call.

But what's interesting in this situation (and all you dyed-in-the-wool conservatives should pay attention) is the difference between personal risk and risk transfer. Insurance, pensions, they are all risk transfer -- not great returns, but returns augmented by the dead pool: those who predecease you. In fact, you've mostly -- for a significant fee -- invested in a bond-oriented portfolio.

Today, the Canadian Life and Health Insurance Association called for more PP3 projects. Why? Because they are a better asset-liability match than stocks are, with better returns than bonds. (And watch out, SunLife or Manulife or OMERS or OTPP could be tolling your nearest highway soon, or building your next hospital).

The fact that the people who provide you with risk insurance are investing more in bond-like assets than in equities ought to tell you something about the nature of risk.

So where does that leave us. Well, first consider the ultimate guarantors of risk -- namely social programmes. A starving wage, to be sure. But social programmes are also a form of risk transfer.

We now have a bounded space: a floor (OAS/GIS/some CPP) and a ceiling (pensions, insurance minimum withdrawal benefits, annuities). The rest is a gravy train, depending on the starting level of wealth and expectations on its increase.

Given that at any time an investor could buy an annuity -- or an RRB -- and thus hit the normal expected rate of return, risk now decomposes into two factors: lifetime savings and expectations of beating the market.

If you don't have enough lifetime savings, the market may or may not help. But you have a floor. You may not like the annuity ceiling, but at least you won't starve.

If you have enough lifetime savings, your risk is simply whether you can beat CPI + 4%, which is the standard assumption for most institutional investors.

Dollar-loss aversion versus percentage-loss aversion is entirely irrelevant, because, like good little econometricians, we assume that people gamble only what they can afford to gamble -- and all market activity is a gamble, even a GIC, except that the bank is making a gamble for you, and for a fee. Risk transfer.

Everyday, we wake up to risk: the bus might crash, the business could fold, the stock market will plummet. We have floors, as I mentioned above, to help people get off the fence and take risks.

But we also have ceilings. If you want to push through that annuity ceiling ...
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