Different Types of Risk in Investing

Risk is what we take the moment our eyes open in the morning. There is a chance the water in the shower could be too cold or too hot; the former makes for a jarring wake-up call, the latter makes for a possible visit to the hospital.

But of course we have knobs that clearly indicate hot and cold, and we also have to ability to feel the water, testing for the moment it reaches perfection.

As the day moves forward the risk increases exponentially. We, however, moderate our lives to adjust for risk. If that nut in the car in front of you looks like he has had too much to drink, you simply switch lanes and move around him, maybe giving him a dirty look as you pass by. You continuously check and assess risk when you drive your car, looking at the rearview mirror every few seconds.

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You are always checking, monitoring, and preparing for un­pleasant events in your life. You probably dread doctor visits (I know I'm not alone in this), and yet the earlier an ailment is dis­covered, the greater the chance of curing or fixing those would-be problems.

We buy life insurance although we avoid dwelling on the inevitable. For the most part we are always checking and as­sessing risk in our lives: Can I really jump over this puddle of wa­ter or should I just take the longer route and stay dry?

And yet you and the overwhelming majority of individual in­vestors don't feel for the comfort level of your portfolio the way you do in the morning shower to make sure it's just right.

Sure, you check out a few quotes, and more and more folks are checking the charts, and that's a start. It should go without saying that when a stock in your portfolio is swerving all over the road like a drunken driver who is five miles from home and has totally let his guard down, you'd better investigate.

Risk in the stock market isn't the actual action of a stock or of the stock market. Risk is a measure of probable outcome and the resulting response of a stock should unplanned but highly pos­sible developments occur.

It's great to know the potential of a company and assume what the upside payoff is going to be—we all do that.

But you also have to assess the worst-case scenario when you buy the stock and throughout the life cycle of the holding itself.

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