…was convincing investors that volatility and risk were the same thing.
This idea that risk cannot truly be measured by looking at volatility (as measured by standard deviation) is well-trod territory in the financial blogosphere so I won’t go into it at length again.
But I do feel as though more than half of all the terrible products, funds and newsletters available to investors make their living by confusing (conflating?) risk and volatility. It’s how Wall Street makes a lot of its money on the wealth management side (upside without fluctuation!) and its why the hedge fund industry is a $3 trillion behemoth (we’re protecting you from drawdowns!).
When we talk to our clients about risk, we characterize it as two very real threats:
a) The possibility of not having enough money to cover a lifespan or fund a specific goal.
b) The possibility of a permanent loss of capital.
Warren Buffett has thought and written a great deal on this topic (as have my other heroes, like Nick Murray, Howard Marks and William Bernstein). His latest annual letter to shareholders contains another fabulous quote on the topic:
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
The modus operandi of a lot of Street denizens is to present something as a problem for you so that they can sell you the solution. By putting the fear of volatility in front of you as though it’s a serious long-term risk, the door is then opened for all manner of high-cost, horrifically ineffective products or strategies. My partner Kris likes to say “the easiest way to sell someone a map is by first convincing them that they’re lost.”
You’re not lost, you’re just invested in an asset class with prices that bob and weave every year. They go up and they go down and sometimes they do both in the same day.
That’s not risk.