What is investment risk?
Most of retail investors don’t care the top risk they should – permanent capital loss. But before we discuss permanent capital loss, let’s review what is a risk first.
Regarding investment risk, I personally think that Buffett’s 1993 shareholder letter provides the best definition: “In stating this opinion, we define risk, using dictionary terms, as “the possibility of loss or injury.”
Investment guru’s opinions
Buffett
“Charlie and I have an aversion to permanent loss of capital.” “I am unwilling to risk a large permanent loss of capital in the pursuit of better long-term performance.”
“There is one investing rule at Berkshire that has not and will not change: Never risk permanent loss of capital.”
In his 1962 letter to his partners, Buffett wrote: “I cannot promise results to partners. What I can and do promise is that a) Our investments will be chosen on the basis of value not popularity, b) That we will attempt to bring risk of permanent capital loss (not short term quotational loss) to an absolute minimum by obtaining a wide margin or safety in each commitment and a diversity of commitments; and c) My wife, children and I will virtually have out entire net worth in the partnership.”
Howard Marks
Howard Marks, the investment guru, who wrote the book “The Most Important Thing“, which I personally think is one of the best books on investment risks, said: “The risk that matters most is the risk of permanent loss.”
“I don’t think most investors worry about volatility. In fact, I’ve never heard anyone say, ‘The expected return isn’t high enough to withstand all the volatility.’ They worry about It’s the possibility of permanent loss.”
Volatility is not risk, permanent capital loss is
Bruce Berkowitz said: “I define risk as the chance of permanent capital loss adjusted for inflation. Volatility, I believe to be just price changes based on market perceptions of risk. Risk does not equal volatility.”
Howard Marks said: “I don’t think most investors worry about volatility. In fact, I’ve never heard anyone say, ‘The expected return isn’t high enough to withstand all the volatility.’ They worry about It’s the possibility of permanent loss.”
David Iben said: “Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital and, increasingly relevant today, the permanent loss of purchasing power.”
Li Lu, who manages Charlie Munger’s family investment funds, said: “In my view, the biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.”
Almost irrecoverable disaster to portfolio
In my post of “The larger the portfolio, the lower the return on investment will possibly be over time”, I mentioned: “Why do famous investors disappear later?” One of the main reasons is that “as long as there is a year’s portfolio return, The rate is extremely low, and it cannot be fully recovered the following year. Most cases will find it difficult to recover, or even never recover from it. “
Causes of Permanent Capital Loss
In my posts of “Why shorting is extremely dangerous to retail investors?“, “Never borrow money, shorting, or derivative products“, and “Retail investors’ wrong investment concept not worth trying at all“, I have discussed some common wrong investment behaviors of retail investors. Unfortunately, many of the actions I have listed are the very causes of permanent capital loss.
In summary, the common causes of permanent capital loss include:
- Take stock market as a gambling place
- Flatten down
- Chase for touted stocks
- Speculative behavior
- Swing trade
- Borrow money to invest
- Stock shorting
- Derivative financial products such as warrants, futures, and foreign exchange
The reasons listed above are not necessarily the cause, but they are the main causes.
Please note: A total stock market crash is not among the reasons listed above, as history has proven that the stock market will recover after a crash. Unless you sell all your stocks when the stock market is at its most panic-stricken, this action proves that you are not suitable for investing in the stock market.
Closing words
Bill Ackman put it this way: “The risk you should be concerned about is the probability that if you invest in a business you will lose money and incur permanent losses.”
Related articles
- “Permanent capital loss is the biggest risk that investors must face“
- “SEC asked: important risks disclosed in financial report“
- “What are the risks investors should face up to?“
- “Should investors care about currency exchange risk when investing in US stocks?“
- “The larger the portfolio, the lower the return on investment will possibly be over decads“
- “Why shorting is extremely dangerous to retail investors?“
- “Never borrow money, shorting, or derivative products“
- “Retail investors’ wrong investment concept not worth trying at all“
Disclaimer
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