All investors know that they need to take risks in order to achieve returns higher than cash. If you asked ten investors if equities were more risky than cash, most would agree. But the true answer depends on how one understands risk.
‘Risky’ means different things to different people. The investment industry has done a poor job of explaining risk as it relates to an investor, and tends to equate it with return volatility.
William Bernstein wrote a great, short booklet on risk, where he explained the different risks that equity investors face, as follows:
“Risk, then, comes in two flavours: ‘shallow risk,’ a loss of real capital that recovers relatively quickly, say within several years; and ‘deep risk,’ a permanent loss of real capital.”
In this volume of Acuity we will address both these types of risk, and throw in a level of our own: ‘mid-depth risk’.