Managing Risk, Accepting Returns

People think of investing as managing money. But it’s really about managing risk.

All-woman skydiving stunt team. Source: Wikimedia. CC-SA-4.0

Risk is the chance that something bad will happen. When we invest, we don’t want bad things to happen to our money. So we try to avoid excessively risky situations. The problem is, there’s no way to insure against all the risks we face with our money. There seems to be an infinite number of flavors of financial risk: credit risk, liquidity risk, inflation risk, longevity risk, shortfall risk, earnings risk, country risk, fraud risk. The list goes on and on. Risk is the price we pay to earn returns.

Every risk involves something unknown. There are risks we know: the known unknowns. We can calculate the odds. In backgammon we never know what any single roll will to be, but the chances of rolling a seven on the next roll are always one in 6 (17%). But some risks we can’t know ahead of time, the unknown unknowns. It’s the unknown unknowns that are really scary. When I played backgammon in college, there was always the possibility that my opponent would get fed up and just walk away.

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Economists and quantitative analysts use the market’s volatility to estimate risk. This gives them with a way to measure how variable returns might be. But this tells only part of the story. The market’s volatility might be low for several years in a row, but that doesn’t mean it isn’t risky. Prior to the financial crisis, risks were piling up inside the balance sheets of several giant banks: Washington Mutual, Golden West, Lehman – banks that aren’t around anymore. When we see excesses building up in the economy, there’s probably something risky going on under the surface.

The best money managers are the best risk managers. The key is understanding both measured and unmeasured risks, and knowing when a risk is worth taking, and when it isn’t.

Douglas R. Tengdin, CFA

Charter Trust Company

“The Best Trust Company in New England”

By |2019-08-14T06:10:29-04:00August 14th, 2019|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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