Risk is an extremely important concept in investing. However, over the years I've discovered that some of the world's best-known investors all have different interpretations of what risk is.
Here are some of the most informative yet contrasting quotes from these investors to give a broad overview of what some of the most high-profile value investors around believe and think on the topic of risk.
Trying to determine risk
"Right at the core, the mainstream has it backwards. Warren Buffett (Trades, Portfolio) often quips that the first rule of investing is not to lose money, and the second rule is not to forget the first rule. Yet few investors approach the world with such a strict standard of risk avoidance." -- Seth Klarman (Trades, Portfolio)
"The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk." -- Seth Klarman (Trades, Portfolio)
"We define risk, using dictionary terms, as 'the possibility of loss or injury.' "Academics, however, like to define investment 'risk' differently, averring that it is the relative volatility of a stock or a portfolio of stocks -- that is, their volatility as compared to that of a large universe of stocks. Employing databases and statistical skills, these academics compute with precision the 'beta' of a stock -- its relative volatility in the past -- and then build arcane investment and capital allocation theories around this calculation. In their hunger for a single statistic to measure risk, however, they forget a fundamental principle: It is better to be approximately right than precisely wrong. "For owners of a business -- and that's the way we think of shareholders -- the academic's definition of risk is far off the mark, so much so that it produces absurdities." -- Warren Buffett (Trades, Portfolio)
"Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earnings power through economic changes or deterioration in management." -- Benjamin Graham
"Each person has to play the game given his own marginal utility considerations and in a way that takes into account his own psychology. If losses are going to make you miserable – and some losses are inevitable – you might be wise to utilize a very conservative patterns of investment and saving all your life. So you have to adapt your strategy to your own nature and your own talents. I don’t think there’s a one-size-fits-all investment strategy that I can give you.” “If we’d used the leverage that some others did, Berkshire would have been much bigger… But we would have been sweating at night. It’s crazy to sweat at night." -- Charlie Munger (Trades, Portfolio)
"However, while volatility is quantifiable and machinable – and can also be an indicator or symptom of riskiness and even a specific form of risk – I think it falls far short as “the” definition of investment risk. In thinking about risk, we want to identify the thing that investors worry about and thus demand compensation for bearing. I don’t think most investors fear volatility. In fact, I’ve never heard anyone say, “The prospective return isn’t high enough to warrant bearing all that volatility.” What they fear is the possibility of permanent loss.
Permanent loss is very different from volatility or fluctuation. A downward fluctuation – which by definition is temporary – doesn’t present a big problem if the investor is able to hold on and come out the other side. A permanent loss – from which there won’t be a rebound – can occur for either of two reasons: (a) an otherwise-temporary dip is locked in when the investor sells during a downswing – whether because of a loss of conviction; requirements stemming from his timeframe; financial exigency; or emotional pressures, or (b) the investment itself is unable to recover for fundamental reasons. We can ride out volatility, but we never get a chance to undo a permanent loss." -- Howard Marks (Trades, Portfolio)
"Risk to us is: 1) the risk of permanent loss of capital, or 2) the risk of inadequate return." -- Charlie Munger (Trades, Portfolio)
Disclosure: The author owns no stock mentioned.
