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Risk Is Ambiguous

May 20, 2012 11:17 PM ET
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rsawyer's Blog
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Seeking Alpha Analyst Since 2012

Risk is an ambiguous term. When you read about it in the textbooks, they will provide you with ways of measuring it, such as with beta, volatility, standard deviations, the ^vix - but what exactly is it? I don't think there really is an answer, and a lot of people get caught up in volatility as the predictor of risk. Or rather, is volatility actually the RESULT of risk? But then we measure risk by how volatile the security is?! Remind you of the chicken and the egg scenario?

Further, what you will find in these textbooks (and from all sorts of pundits and analysts) is that there is such thing as a risk free rate. What is this risk free rate! There is no such thing as a risk free investment, period; it just doesn't exist.

Most people want to characterize t-bills as the risk-free rate; however, just off the top of my head, I can think of all kinds of risks you have with t-bills: namely, you have interest rate risk, default risk (yeah yeah, "full faith and credit…" blah blah blah), risk that the currency will be debased and you will actually have a negative return, just to name a few. Does that put a kink in your knowledge of finance?

Personally, I find treasuries (and anything to do with bonds inherently risky); number one, you're taxed on the interest at ordinary rates (that's an immediate 15-35% loss). Second, your ultimate return is controlled by forces you have no control over, namely the Federal Reserve. Now we are getting somewhere.

Investing in stocks allows you to read financial statements of your investees, vote on pertinent matters, and obtain relevant information related to your investment decisions. In contrast, for purposes of bonds, how many times have you been able to listen in on the FOMC Meeting? How many times have you been able to vote on interest rate changes? This gets me to my point:

All investments have two kinds of risks: inherent risks and control risks. Inherent risks relate to those that are going to be there no matter what. Control risks are the risks that you can't control with your own actions. In short, you can control a company; but you can't control the Federal Reserve. Why would anyone invest in bonds? Beats me.

But anyway, what I'm trying to get at here is that risk is not a function of volatility; it's a function of how accurate you think you are and how well you can control your risks. If you are 100% sure your investment is going to return a certain amount (and you can make sure of that), by all means it's a risk-free investment.

And if you are 100% sure that this investment is the best, why the hell would you diversify?! What burns me up more than anything is the notion that you should diversify, and that people actually recommend percentages of asset classes to do so! How retarded is that? It's proven backwards, forwards, and sideways that stocks outperform every other asset class. Why anyone would dilute their return by diversifying is beyond me.

So, in short, there are times when your return is going to outweigh your non-controllable risk; and during those times, you go all in. If the count is 3-0, the bases are loaded, and you're up to bat, you should rare back and hit the ball as hard as you possibly can, because you're likely to get one right down the pipe! But how do you know when the count is 3-0? I suppose we'll save that one for another day.

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