Do private investors view risk as standard deviation or some other statistical measure of volatility? The answer is No.
Private investors view risk as their accounts going down in value. Period. What concerns them, is that drop (or draw-down) in account value becoming permanent and affecting their lifestyle.
We measure risk in a way clients can relate, by the percentage draw-down of their account, and we deploy strategies to actively manage that risk.
While measuring risk as a % draw-down is an improvement to measuring risk with volatility, standard deviation, or any other statistical term, Is it really the risk we should be most concerned with?
Take a look at this table:
All markets will experience periods of negative return, that’s inevitable. Don’t let the potential for negative market environments and the emotions that come with that scare you into missing out on the strongest combination I know of: Time + Interest. Every investor has a different horizon and risk tolerance, but for those of us with a horizon that’s 10 years or beyond…take a hard look at the numbers in the chart above.
Build a portfolio with sufficient expected returns within your risk constraints, and let compound interest flex for you. Missing out on their synergy is the Real Risk.
Do you know your portfolio’s expected returns and the true cost or drag on those expectations? If not, it’s worth looking into.