What is risk?
There’s a saying that volatility is not risk, that risk is a permanent loss of capital, and that price fluctuations are temporary until you sell and make them permanent. Well, maybe. If I bought Amazon at 400 late last year and sold it when it hit 300 this year, I lost out, right? Not if I put the money into Google—it would have recovered what Amazon lost.
Selling a stock doesn’t make your loss permanent. It just transfers your ownership from one asset to another. If you shift from stocks to cash, that decision may be prudent—or not. But when the price goes down, you have a loss. Your loss may be short-term or long-term, but the loss is real.
Some prices are less jumpy than others. The price of Coca-Cola stock has been more stable than Oracle’s
We capture this jumpiness mathematically with the statistic known as volatility. It’s generally true that stocks that go up quickly (like Oracle) can also come down quickly. They’re more volatile. This is risk.
Those who say that volatility isn’t risk are often trying to sell some quirky idea of capital markets. But to borrow a line from Warren Buffett when he was questioning compensation accounting, if volatility isn’t a drop in the price, what is it? And if a drop in the price isn’t risk, what is it?
Risk isn’t just volatility. But it’s at least volatility.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!