The risk factors

Great investing requires both generating returns and controlling risks. And recognising risks is an absolute prerequisite for controlling risk.

Investment risk is largely invisible before the event – unless you have some unusual insight – and often still murky after the event. Most financial disasters have therefore occurred due to the failure to foresee and manage risk. This occurs because, risk only exists in the future and we all know it is impossible to know what the future holds. There does not seem to be any ambiguity when we view the past as only the things that happened, happened.

Understanding, identifying and controlling risks are extremely important components of strong portfolio management.

Investors tend to overestimate their ability to gauge risk and understand the mechanism of events they have never seen before. In general, humans do not have to experience something to know if it is dangerous or not, but for some reason, during bullish market periods, investors do not perform this function of identifying risk prudently. Instead, they tend to overestimate their ability to understand and foresee the complex financial market’s web, especially with new information coming in each day.

So the question remains, how do you measure risk? To put it simply, it is nothing but a matter of opinion. You can have an educated and hopefully skilful opinion or estimate of the future we see, but it is still an estimate.

Source: Howard Marks – The Most Important Thing