Sizing up investment risk

In finance, risk and return are usually linked together in my view.

If one is searching for higher returns, one must be prepared to bear additional risk.  Conversely, if you want lower risks, you will probably wind up with smaller returns.

Risk Metrics

In the stock market, there are a variety of ways to think about risk such as beta, a measure of risk and volatility of an individual asset relative to the whole market.

Volatility tracks the historical fluctuation of an asset and can be also measured in terms of standard deviation, a statistical measurement that in finance is usually applied to rate of a return of an investment that also sheds light on historical volatility relative to a mean.

Then there’s the risk of a permanent loss of capital on an investment. That could happen if a company takes a severe hit to earnings power or goes bankrupt.

Headline Risk

That’s probably the biggest risk for investors, but there is yet another in my opinion: paying too much for an asset.

Recently, investors have decided that the risk from a data breach at Facebook (FB) and possible future regulatory scrutiny is far too high at the current market price.

The same thinking applied when President Trump criticized Amazon (AMZN) over how it handles its tax obligations, whether correctly or incorrectly.

Both of these situations are related to the risk of paying too high a price for a quality company.  


Investors only have so much capital, and if you pay too much for assets, you may put yourself at quite a disadvantage in my view.

It will be interesting to see how things play out at Amazon and Facebook, but the risk issue, in whatever form, is one which is worth remembering in my opinion.

Photo Credit: Paul Cross via Flickr Creative Commons