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Thu, 20 May 2010 - 15:40

The Definition of Risk

One of the Daily Equity Report's readers recently posed an extremely relevant question to the Daily Equity Report on Risk Appetite last week (click here). Paraphrasing his email,

".when you talk about risk and the market commentators refer to the overseas investors being either risk averse or prepared to take on risk, I feel that the word risk is becoming a buzzword and the man in the street needs to be informed what the word really means for him. I feel that investing in fixed interest bonds contains a degree of risk as opposed to the general implication that investing in shares represents an investment that represents risk. Are there measures that are used in today's climate to classify/quantify or give more meaning to the word risk?"

Risk is a word that is often bandied about, and it is important to understand the context within which it is used to decide whether it is relevant to you. Let's take a look at some of the definitions of risk:

Risk = Volatility This is typically the most common meaning of risk. If the price of an asset is volatile then it will be described as risky. As your time horizon increases, so the volatility of an asset class typically decreases, and this risk diminishes.

Risk = Not Reaching Retirement Targets Over the long term the risk of not meeting your retirement targets is possibly the biggest investment risk that you face. The irony here is that you need to take a certain amount of risk over the shorter term (i.e. invest into volatile assets) in order to reduce the risk of not being able to retire comfortably over the longer term.

Operational Risk versus Investment Risk Investment risk can simply be defined as the risk that the assets purchased don't perform in line with expectations. Operational risk, on the other hand, is the risk associated with the product or product provider. While the outcome of investment risk is typically in shades of grey (i.e. performance might not be great, but you do get a small return) operational risk is often a binary event (i.e. your entire capital investment is subject to operational risk). It is therefore imperative that your investment is in an operationally sound vehicle and with a reputable manager.

Risk = Permanent Loss of Capital When talking and thinking about risk, Seed defines risk as the risk of permanently losing capital. This permanent loss can stem from buying assets that trade far above their value, by investing in vehicles that aren't operationally sound, or investing with dishonest managers. Seed seeks to minimise these risks as far as possible.

Change in Risk The changes to your risk profile are predominantly dictated by the changes in your personal circumstances. This is the case both for individual investors and corporate operations alike.

Ultimately investing is about taking risks, some of the different risks have been described above. Investors should remember that when taking any risk there should be a comparable potential reward for taking on that specific risk.

Take care,

Mike Browne info@seedinvestments.co.za www.seedinvestments.co.za 021 9144 966

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