Quick! When I say, “Investment risk,” what comes to mind? Naturally and instinctively, for most readers, it’s, “Volatility!”
Many investors act as though “risk” and “volatility” are interchangeable. And they often are! Volatility is a key risk that investors should consider (though, often, it can matter over what time period you consider volatility, as discussed in Chapter 1). And volatility is the risk that, most of the time and over shorter periods, investors feel most keenly.
It can be heart-stopping to watch your equity allocation—whether it’s 100% of your portfolio or just 10%—lose up to 20% fast, as can happen in corrections. And even more grinding to watch it fall 30%, 40% or more in a big bear market. Ultimately, equity investors put up with volatility because finance theory says (and history has supported), long term, you should get rewarded for that volatility—more so than in other, less volatile asset classes.
But volatility isn’t the only risk investors face. There are myriad! As discussed in Chapter 1, folks often believe bonds are safer. But there’s no universally accepted, technical definition of safe. And no bond is risk free. Bond investors face default risk—the risk the debt issuer delays payments or even goes bankrupt! It happens—even to highly rated firms. Default risk in US Treasurys is exceptionally low—so much so professionals often refer to it as the “risk-free” ...