MISTAKE 57Do You Understand the Nature of Risk?

Since we live in a world without crystal balls that allow us to clearly see the future, prudent investing is all about the management of risk and expected returns. A problem that both investors and investment advisors face is defining what exactly is risk. As you will see, risk can be many different things. And since risk can be many different things to different people, investors and advisors are faced with deciding which risks are the most important to manage.

The most commonly used academic definition of risk is standard deviation—a measure of volatility. Unfortunately, two investments with similar standard deviations can experience entirely different distributions of returns. While some investments ...

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