Home' Trinidad and Tobago Guardian : November 20th 2014 Contents BG18 COMMENTARY
BUSINESS GUARDIAN www.guardian.co.tt NOVEMBER 2014 • WEEK THREE
The word "risk" is one of the
most ubiquitous concepts
in that it is present in every-
thing that we do. Every
action or even inaction car-
ries a risk. Risk is something
that can either be accepted, managed, trans-
ferred or avoided. In order to choose any
of these paths you first need to understand
what risk is and then, specifically, identify
the risk that you are dealing with. Note,
risk is often in the eye of the beholder and
may mean different things to different people
in different times and circumstances.
I will deal with various aspects risk over
time but the focus today is on investment
Understanding investment risk is essential
to making good investment decisions. More
importantly, there are many people who
invest but have not quite grasped the concept
of risk and how it impacts on investments.
Further, the investment landscape and your
life circumstances are both ever evolving so
appreciate that risk is not static but is also
Recognise that risk is defined differently
by an investor and by a portfolio manager
and many times these differences in def-
inition leads to misunderstanding between
both parties. A good starting point in terms
of investor education is to discuss risk from
the perspective of the portfolio manager.
This will hopefully give you an insight into
what is occurring when you sit in front of
an investment adviser to discuss how to
invest your money.
The first point to appreciate is that risk
is measurable and this is done by calculating
the volatility of returns or the price volatility
for a stock, bond or any other asset. So from
the perspective of a portfolio manager, risk
is not about gains, losses, fear, not being
able to retire or going on a vacation. Risk,
in this context, is a statistical measure that
can be numerically defined. The most com-
mon measure of risk is the standard devi-
ation of returns. However, instead of going
into the details of how this is calculated,
you might better appreciate the concept via
Let s take two hypothetical companies,
Steelband Ltd and Calypso Ltd. You paid
$11.65 a share for Steelband a year ago and,
at the same time, $15 a share for Calypso.
The table shows their share prices at the
end of each month.
Both stocks earned a rate of return of 20
per cent for the year (rounded to the nearest
whole number). On the face of it you will
probably think it did not matter which com-
pany s share you held in your portfolio.
A closer look at the table reveals that
Steelband s share price was more volatile
than Calypso s.
Returning to the math, the standard devi-
ation of Steelbank s stock was $3.02 or 21
per cent of the average month-end share
price of $14.58. Calypso s share price had
a monthly standard deviation of $2.77. This
was only 16 per cent of its average month
end share price of $16.80
Risk and return are related.
Greater risk should result in a greater rate
of return and vice versa. This is called the
risk-return trade-off. Both companies gen-
erate the same annual return of 20 per cent
but it was decidedly less risky to invest in
Calypso than in Steelband. Calypso was
therefore the more "valued" investment
because it carried a lower risk/return profile
The above scenario applies to all assets,
not just shares in the stock market. You can
categorise almost any class of assets by the
degree of risk. Stocks have historically been
considered riskier than bonds and bonds
riskier than cash. Note that this assessment
is simply based on potential volatility of
returns. If one were to look at risk from a
different context you are likely to get a dif-
ferent analysis. That issue will be dealt with
in subsequent columns.
In addition, within each asset class (eg
companies listed on the stock market) some
investments are riskier are others. It is there-
fore imperative you understand the risks
associated with the companies that you are
Among those investments that are con-
sidered to have a lower degree of risk are
balanced mutual funds, money market
accounts and cash deposits which are insured
with the Deposit Insurance Corporation.
Investing in government-backed instru-
ments---treasury bills and bonds---are con-
sidered among the safest of all investments.
However, they also offer the lowest com-
Your tolerance to risk
In order to put together an investment
portfolio, an adviser will want to assess your
tolerance to risk.
Recognise again that this is an assessment
of how you see investment risk as defined
by your investment adviser. It may not be
the same as your concept of risk but it is
a starting point for the conversation on risk.
Your risk tolerance is an approximate
measure of your willingness to accept invest-
ment risk. If you are termed an aggressive
investor, you re more likely to accept the
risk of losing some of your investment in
exchange for the chance to earn a higher
rate of return. I do not like the concept of
aggressive, moderate or conservative profiles
for investors since my research shows that
it often leads to suboptimal investment deci-
sions that are not in the investors best inter-
est.However, this is the perspective from
which the industry and even the regulators
approach the issue of risk so this is where
the conversation has to start.
After assessing your risk profile the next
step is to determine if your current financial
circumstances support your risk tolerance.
You may have the appetite for risk but may
not have the resources to satisfy this appetite.
Once you have put this together, select the
assets you would like to have as investments
in order to meet your objectives.
For specific investment advice, you should
consult a financial adviser.
Ian Narine is a broker/dealer and invest-
ment adviser registered with the SEC.
Risk tolerance quiz
To get an idea of your risk tolerance, take a few
minutes to complete the accompanying risk tolerance
If your total score is 30 or more points, this quiz
suggests that you are a very aggressive investor. If
you score between 25 and 29 points, consider your-
self an aggressive investor.
If you score between 20 and 24 points, your have a
risk tolerance that is above average. If you score be-
tween 15 and 19 points, consider yourself a moderate
investor. This means you are willing to accept some
risk in exchange for a potential higher rate of return.
If you score fewer than 15 points, consider yourself
a conservative investor. If you have fewer than 10
points, consider yourself a very conservative investor.
1. I plan on using the money I'm investing...
a) after 7 years or more.
b) between 3 and 6 years.
c) within the next 3 years.
d) within the next 6 months.
2. The money I routinely invest represents
what percentage of my total assets (not in-
a) Less than 25 per cent.
b) Between 25-50 per cent.
c) Between 50-75 per cent.
d) Greater than 75 per cent.
3. Over the next five years I would choose in-
vestments that can cause my income to....
a) ...grow quickly."
b) ...grow ahead of inflation."
c) ...grow slowly or not at all."
d) ...decline if I factor inflation."
4. Do you have emergency savings?
a) Yes more than enough.
b) Yes just about enough.
c) Yes, but less than I'd like.
5. I would feel comfortable risking ___ per
cent of my money available for investing if
the chance of doubling it was 50 per cent.
a) ...50 per cent
b) ...25 per cent
c) ...10 per cent
d) ...0 per cent
6. Have you ever invested in individual stocks
or stock mutual funds before?
a) Yes, and I was comfortable with it
b) No, but I look forward to it.
c) Yes, but I was uneasy with it.
d) No, and I don't want to.
7. What do you want your money to do for
a) Grow as fast as possible; current income not im-
b) Grow faster than inflation; produce some in-
c) Grow slowly and provide a nice income when I
d) Preserve principle, no matter what.
Adapted from (US) Securities Industry As-
4 points for every (A) answer
3 points for every (B) answer
2 points for every (C) answer
1 point for every (D) answer
The meaning of risk
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