Chapter 8 – Understanding Risk
Risk is one of the most important components of all kinds of investing - but risk can also be a complicated issue. There are many measures and definitions of risk: volatility - the up and down movement of the market - is just one measure. Traditional investors only worry about volatility when shares are falling. Some investments are made for the long term, so short-term volatility is not necessarily a reason to panic and make drastic changes to a portfolio. Other measures are personal and vary from investor to investor. As always, past performance is not a reliable guide to future performance and may not be repeated.
Many use a scale of 1-10, where a very low-risk cash placement is 1 and a very volatile placement is rated at 10. Different funds will have different risk profiles. For example, an emerging market equity fund will be deemed to be higher risk than a blue-chip equity fund, as emerging market economies are considered less well-regulated than those in the markets blue chip stocks trade in.
Even within each sector, different funds or managed accounts will or can have different risk profiles too - one emerging market equity fund or placement may be riskier than another. Risk-ratings are based on the past performance as well as other historical data on how the strategy has performed in certain market conditions and this data can help match the investor to the fund. Some strategies can be deliberately packaged by asset management groups to attract investors based on their attitude to risk. It's worth noting that risk profiles can change with time and a rating of portfolios will be adjusted to ensure it aligns with the future risk profile of the investment.