How measure risk?

The quote in today’s paper is, “is a fund that drops 60% only medium risk?”

I submit that the question is subtly improper. An analogy may help me here.

There is a sin amongst bridge players called resulting. That’s when the merit of a risk-based playing decision is based on the result, after the fact. If I decide to take a 50-50 finesse in preference to playing for a one-in-five singleton, and the finesse loses while the drop wins, then saying my decision was bad is just resulting. Over a large number of similar decisions I would have made the better choice more often than not.

It is conceivable that, of all the existing medium risk funds, one or a few will drop 60% due to extremely unlikely circumstances. The vast majority will not. That statistic is what made the group as a whole medium risk.

Buying a lottery ticket is a dumb decision. (I do this, although I do call it a tax on the gullible.) Your chance of a good return are extremely poor. However, whoever wins the jackpot, could claim that it was a brilliant, informed decision to buy the ticket. This is also resulting.

Risk often cannot be measured by one outcome, it can only be measured by a large collection of outcomes. This is true when the mechanisms generating the result are poorly understood. I submit that the stock market could be one such mechanism.

So the question about the fund should be, at the time of the purchase decision, was information available to single this fund out in any way as being different from the general herd? If there was no reason to suspect high risk, then the risk could have been medium – given the information present at that time.

Medium risk means crashes are rare. It’s like driving, or watching a thunderstorm. You could get hit by a rare event. We live with this daily.

Now if the fund in question were specifically advertised in words that said it could not drop sixty percent under any conceivable conditions, then the buyer would have a case when the fund crashed. I doubt such wording was in the information provided, eh?

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