This month’s cover article (What Risk Is – and Isn't) makes the somewhat controversial assertion that “risk cannot be measured.” Howard Marks’ point is exactly right: what is commonly measured and referred to as risk (volatility) isn’t what investors are actually worried about (losing money).
Not only that, but assuming financial outcomes will be “normally distributed” according to standard statistical analysis rules (explained in the table below) is, in fact, risky.
Despite these shortcomings, SMI still attempts to measure risk because it’s such an important aspect of investing. As Marks also points out, “when you consider investment results, the return means only so much by itself; the risk taken has to be assessed as well.”
The answer, then, is not to give up trying to measure risk simply because it can’t be done perfectly. Rather, it’s to clearly delineate between what we are measuring and what we’re not, and what are the appropriate uses — and limitations — of that information.
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