Investment Risk and the Risk/Return Tradeoff
The Investment Risk/Return Tradeoff and the Dangers of Market Timing
What Is Investment Risk?
The Technical Definition:
Investment risk is a measure of how far the actual return can be expected to vary from the expected return in any given year. We calculate investment risk by measuring how far the actual return has varied from the average return over an historical period.
Investment risk is measured using a number called standard deviation. Standard deviation marks the range within which the actual return will fall 67% of the time. For example, a portfolio with an expected return of 10% and a standard deviation of 20% will have a 67% chance of generating a return of between -10% and +30% in any single year. To calculate a 95% probability, just calculate returns using two standard deviations. So the same portfolio with an expected return of 10% and a standard deviation of 20% has a 95% probability of achieving a range of returns of -30% to a +50% return. (2 * standard deviation)
The not technical or How most people define risk Definition:
Risk is the possibility of losing money. This definition only recognizes risk on the downside. It is important to remember that volatility works on the upside as well as the downside. We all want low volatility on the downside and high volatility on the upside.