Risk

[rokid]

Modern Portfolio Theory (MPT) postulates that excess returns are the reward for the assumption of risk. However, all risk is not compensated. Only the risk associated with the market is compensated. Risk that can be diversified away is not compensated. For example, investors are rewarded for holding the C Fund. However, they should not expect to be compensated for holding a penny stock, no matter how risky.

I started reading an on-line book by Aswath Damodaran. At the beginning of the second chapter he introduces the Chinese pictogram for risk (see the attachment). The pictogram is a combination of danger and opportunity. Pretty much sums it up - risk is the combination of danger and opportunity! No opportunity without some danger. No free lunch.

 

[rokid]

Here's some indication of just how risky the markets can be.

The ten worst stock market crashes:

http://stocktaleslot.blogspot.com/2006/10/10-worst-stock-market-crashes-in-us.html

Market returns courtesy of gummy:

http://www.gummy-stuff.org/returns.htm

 

[rokid]

The short article, Volatility, Fat Tails And Mean Reversion (Again) by David M. Blitzer, appears in the May/June 2007 issue of the Journal of Indexes. Essentially, Mr. Blitzer reminds us that the markets are much more volatile (risky) that normal distributions or recent experience would imply.

I found his chart of one day moves of the S&P 500 (1990-2007) quite interesting. The one day moves range from a positive 6% :laugh: to a negative 7%. Losing $70K on a $1M portfolio would certainly ruin anyone's day.

http://www.indexuniverse.com/JOI/index.php?id=827