In his blog Novel Investor, Jon writes about what is the risk and how investors approach it. He has used ideas developed by Peter Bernstein to underline this point which is quoted below.
On risk: The biggest risk is not knowing what you are doing.
On survival: The derivation of the word “risk” reaches back to the early Italian “risicare”, which translates as “to dare.” Risk looked at from this viewpoint is a choice rather than a fate. For a true long-term investor, the choice, by definition, must be survival, or you can forget that long-term stuff. (Warren Buffett has said that to finish first, you must first finish.)
On time dimension of risk: We must learn to act before we have complete information. By the time all the information is in hand — if it ever is — the odds are high the moment will be too late for us to act. Risk has a time dimension, which means procrastination inevitably transforms the nature of the risks we face. Bernstein does not mean to suggest that procrastination is inherently the wrong choice. It is a cliché to say we cannot ever read the future, but the effort to locate the critical point between information we can trust and information we can only guess is an indispensable ingredient of successful investing. There are, Bernstein admits, occasions when we are convinced the short-term news is only noise and the real information is in longer-term trends. But the difference is a mirage: We must still distinguish between trusting and guessing.
On risk management: Risk means the chance of being wrong — not always in an adverse direction, but always in a direction different from what we expected. Risk management, then, should be a process of dealing with the consequences of being wrong. Risk management should concentrate either on limiting the size of bets or on finding ways to hedge the bet so you are not wiped out if you take the wrong side. Risk management is fundamentally different from managing volatility, which is how many investors view it. Volatility is often a symptom of risk but is not a risk in and of itself. Volatility obscures the future but does not necessarily determine the future.
On the lesson of history: The constant lesson of history is the dominant role played by surprise. Just when we are most comfortable with an environment and come to believe we finally understand it, the ground shifts under our feet. A surprise is a rule, not the exception. That’s a fancy way of saying we don’t know what the future holds. Even the most serious efforts to make predictions can end up so far from the mark as to be more dangerous than useless. All of history and all of life is stuffed full of the unexpected and the unthinkable. Survival as an investor over that famous long course depends on the very first on the recognition that we do not know what is going to happen. We can speculate or calculate or estimate, but we can never be certain. Something very simple but very penetrating stems from this observation. If we never know what the future holds, we can never be right all the time. Being wrong on occasion is inescapable. The most important lesson an investor can learn is to be dispassionate when confronted by unexpected and unfavourable outcomes.
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