I will be blunt. I am frustrated by the assertions I read and hear about risk. Most of what I read is mistaken and the academics have it completely wrong.

An otherwise brilliant economist and mathematician won the Nobel Prize for creating a theorem based upon volatility being used as the measurement for risk.

I doubt I will get a Nobel Prize for pointing out that volatility is not the same as risk.

The real risk we face when investing is losing money. Losing money is unpleasant and undesirable. Volatility is also unpleasant, but it can be desirable unless it leads to losses.  Volatility often leads to making money. Clearly risk and volatility are not the same.

I try to avoid risk, but I do not necessarily try to avoid volatility and I certainly do not measure the riskiness of an investment by guessing how volatile it might be.

If I focused on the volatility, I might overlook the true risks and that might be a bad thing. An investment that has low volatility can be very risky. Volatility is not the same as risk and it is not a true or sensible measure of risk despite academic papers that depend upon them being the same.

A good starting point for judging risk would be to purge any thoughts regarding volatility. Unfortunately, many people in the investment world and media have fallen prey to confusing volatility with risk when they speak and write. This leads to investors misunderstanding the true nature of their investment portfolio, often feeling uncomfortable about good investments only because they are described in the media as risky.

For the last few years, it has been popular to describe market activity as being either “Risk on “or “Risk off”. The implication is that when the stock market is rising investors are investing in risk assets and when investors flee to government bonds, they are avoiding risk. In that context what risk “on or off” really means is moving into or away from the volatility of the stock market.

Here is a recent example of convoluted thinking printed last week in The Globe and Mail. An actuary was quoted as saying “…keep risk-free investments like bonds and GICs…” and in the prior paragraph quoted as saying “My best estimate is that the return on bonds over the next 20 to 30 years is going to be negative”. To be fair I have not printed the whole opinion (partly because of copyright issues) but my point is simply that the actuary describes an investment that he believes will lose money as risk free. This type of convoluted thinking gets printed all the time.

Reducing wealth is the same as losing money only it considers both inflation and taxation. Moving into government bonds or GIC's at current rates may get you less volatility, but I can assure you they are likely to reduce your wealth.  Earning 1.5% on a 5-year GIC or 1.25% on a 30-year government bond is guaranteed to lose wealth, even if you pay no tax, when inflation is targeted to be 2% or more. If interest rates rise the government bond price will drop and actually prove to be very volatile. A GIC just hides the volatility by locking investors into the GIC until maturity. These don’t seem like risk free choices to me.

Owning a well-diversified basket of stocks is a lot less risky than owning bonds. I think I will make money over the years after tax and after inflation. Yes, I will endure the unpleasant effects of volatility, but I won’t be fooled into holding risky investments that are expected to lose me money.

Volatility is a problem if one requires their money at inopportune times. Consequently, I always prefer a long-time frame for owning that well diversified basket of stocks. That doesn’t mean it is the same thing as risk. It just means it needs to be managed.

Volatility is also opportunity. It can often provide an opportunity to upgrade one’s portfolio. In that case volatility is our friend and not a risk.

p.s.

We need to think clearly about risk. Imagine I told you in 2019 I was borrowing $1,000,000 to buy a condo in a good location in Toronto as an investment for rental income.

Would you have thought that was risky? Prices were high but rentals were strong. At the same time, it is a lot of eggs in one basket.

One year later condo prices are dropping, and rental income is dramatically down.  In retrospect it was risky. Tenants are hard to find and the resale market has some headwinds. Perhaps, this is truly just some volatility and it will be ok in 5 years.

Imagine I told you I could borrow $1,000,000 at an after-tax cost of less than 1% for 5 years and that I was going to invest it in a diversified basket of stocks for at least 5 years. I suspect most people would have the gut feeling that borrowing for the diversified portfolio is very risky compared to borrowing for the concentrated holding in one condo. Why?