Risk is always top of mind for investors. To most, risk is related to volatility; specifically, downside volatility, or the potential to lose money.

It is widely believed that risk can be measured and classified as low, medium, or high. The assumption is that a low-risk investment will decline less and/or face fewer setbacks compared to medium- or high-risk investments. Focusing on the times that markets behave in the usual manner makes it quite easy to subscribe to this view. However, there are plenty of instances when markets are not neat and orderly.

Risk is not stable. Further, it is not limited to what we already know or what we have previously seen. For example, we cannot assume that the past ups and downs of different investments make up the full spectrum of possible outcomes. Thus, we have no idea what the best-case or worst-case will be. Risk is unpredictable. Managing it requires imagination, not calculators. To be clear, I think risk is when an investment portfolio falls thirty or forty percent in value even though a model suggested it would only fall by twenty.

It is also common to assume that a once in a century event is so rare that we can leave it out of our risk analysis. Again, the industry tends to focus on the normal range of outcomes. However, we know that a once in a century event should be expected to happen once every hundred years. Moreover, there may be fifty, sixty, or seventy such once in a century events, in which case you can imagine the odds are quite high that several of them will happen during your investment horizon. To me, risk is not the ninety-nine percent probability of a familiar outcome. Rather, it is the one-percent probability of being completely surprised.

One of my favourite thinkers on all things risk is Nassim Taleb. He suggests that people would often prefer to have a map of New York when they are lost in Paris, than to have no map at all. Of course, just because you have a map of New York, does not make it useful in every situation. We know this. It is silly to use that map in Paris simply because it is the only map you have. Though, investors tend to make a similar mistake all the time. Hindsight bias regularly has an outsized influence on our understanding of risk and ultimately on our investment allocation decisions.

Despite its insistence that past performance is not indicative of future results, the investment profession leans very heavily on past information (read: Map of New York) to guide clients (read: Lost in Paris). While it may be comforting to assume that we can look backwards to predict how investments and markets will behave through time, we know that we cannot. Thus, to me, proposing that one investment portfolio will be less risky than another is quite a leaping conclusion. Importantly, I do not think it is necessary. In our case, I think we can chart a good course that embraces the inherent unknowns, rather than wishing them away.

“How?” – you may be asking.

Do not overcomplicate things.

Try this: Instead of asking, “How much risk do you want to take with your life savings”, ask, “How much of your life savings do you want to take risk with”. See where that leads. I suspect it will be an easier path for most to a disciplined, long term, investment strategy.

Next month I will dive deeper into this idea. In the meantime, if you want to learn more about our team or our advisory process, feel free to connect with myself or Louise.