Risk – what is it really?

Jeremy Walter writes that perhaps one of the most confusing word we use in finance – and perhaps in life in general – is risk. We are reminded of the different types of risk that investments are subject to market risk, strategy risk, small company risk, turnover risk, limited market risk, concentration risk, interest rate risk. We have risks in life that we commonly insure against. Our homes burning down. Our vehicles being totalled. Our physical ability to earn income. Us or loved ones dying earlier than expected. Healthcare and medical expenses. We have risks that we don’t think about as frequently. Inflation risk. Longevity risk. Income stability risk. Legal liability risk. And these are just the financial types of risk in our lives.

But what is the risk? Oftentimes people define it as the loss of something – which is true but perhaps doesn’t capture all dimensions of it. Walter thinks the risk is simply the chance that something doesn’t go according to plan. And if we accept that, then we need to accept the fact that our plans – financial and non-financial– need to be flexible and need to be able to adapt. In addition, the more complex the situation, the more different, independent risks and variables are involved.

We just acknowledge that risk is the price of admission to anything worthwhile. There are some types of risk that you can insure against. There are other types that you can diversify against. And there are other types you simply can’t do anything about. It’s virtually impossible to eliminate all risk. And that’s ok. As long as we’re aware of it, and we recognize the importance of flexibility. So again – the risk is three things. Risk is (1) a part of life that (2) accounts for things not going according to plan, but (3) is the price of admission for achieving anything worthwhile.

And once we realize it, maybe the risk isn’t as scary – nor as difficult to define – as we think.