Plan Your Prosperity: The Only Retirement Guide You'll Ever Need, Starting Now--Whether You're 22, 52 or 82

Potential Pitfall: Ignoring Opportunity Cost

In the investing world, professionals, pundits, investors—most everyone—often talk about risk when they mean volatility. The two are often interchangeable—and should be! But not always. Make no mistake, volatility is a key risk every investor faces and must consider, unless you’re doing true, long-term capital preservation, which likely isn’t the case for most readers of this book.

But it isn’t the only risk! Thinking only or primarily about volatility can result in decisions that decrease the likelihood of reaching your long-term goals. For example, there’s interest rate risk—the risk interest rates fall, and when a bond matures, comparable bonds have lower (maybe much lower) coupon rates. Hence, you reinvest into a lower rate. There’s inflation risk (covered in Chapter 2). There’s political risk, exchange rate risk, liquidity risk—myriad kinds of risk.

In 1997, I wrote a paper on risk with my friend and sometimes research collaborator Meir Statman (the Glenn Klimek Professor of Finance at Santa Clara University’s Leavey School of Business) titled “The Mean-Variance-Optimization Puzzle: Security Portfolios and Food Portfolios,” which was published in the Financial Analysts Journal.

In it, we discuss how people think about food often parallels how investors think about investing. Diners don’t just want nutrition—they want it to look good and taste good. And they want to eat the food at the right time of day—people feel weird eating hamburgers ...