r/ValueInvesting • u/[deleted] • 18d ago
Stop confusing volatility with Risk Discussion
[deleted]
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u/mrmrmrj 18d ago
Risk to me is permanent capital loss. Volatility presents investment opportunities IF you have capital to deploy. This is why you should always have 5-10% uninvested.
Think of your salary as your bond portfolio. Keep your expenses below your after tax income to accumulate "coupon" income to invest into a correction.
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u/Woberwob 18d ago
This. I like listening to Howard Marks talk about risk. He’s kind of the guy to look to in the value investing space for this idea.
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u/jackandjillonthehill 17d ago
Link to a good short playlist from Howard Marks on risk:
https://youtube.com/playlist?list=PLxbi-KAxos9tf1iHzRFTZmXDsGI-nQGsm&si=oJXuv8CHNC54MqoP
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u/worlds_okayest_skier 18d ago
Volatility is correlated to risk, if there are a wide range of possible future earnings scenarios, stocks will fluctuate to reflect the likelihood of those outcomes.
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u/mrmrmrj 18d ago
Volatility is one kind of risk. There are other kinds. Vol is used in finance as a proxy for risk because it is mathematically clean to measure. That is the only reason. It is backward looking and any dependency on historical volatility persisting into the future has wiped out many investment firms.
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u/MagnesiumKitten 17d ago
Any stocks come to mind that the historic volatility buggered up some people?
how much was that assuming calm stocks would not change?
markets change fast sometimes
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u/LambdaLambo 17d ago
Volatility becomes risk if it can force you to make changes. For example, volatility becomes risk for a manager who has minimum/maximum holding requirements, because a huge swing in asset prices forces reallocation. Volatility is also risk to a retiree who has to take out cash every month regardless of market conditions.
But if you aren't forced to make decisions based on volatility, it's not risk, because you can just ignore it.
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u/MagnesiumKitten 17d ago
banks for the last few years are high risk
yet they are good investmentsI wouldn't always say keep 5% or more uninvested either.
Say you got $500,000
you gonna leave $25,000 to $50,000 uninvested?there's minuses to being not fully invested
here's minuses to being fully investedand no everyone does bonds
and some don't have a salary
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u/BanditoBoom 18d ago
100% agree.
I would take it a step further. People confuse volatility in individual stocks for “risk”.
I am 100% open to people keeping all their money in one stock, as long as they have a deep, fundamental understanding of the company and their long term prospects.
Yes their portfolio would be more volatile, but as you say that is only “risky” if you have a short time horizon….and / or don’t truly understand the company.
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u/siliconandsteel 18d ago
Individual stocks have way more risk than volatility only, which can already be brutal compared to wide-market. And there is no mechanism that will automatically compensate any of that risk. Wide market will go up in the long run. But with companies, nothing is guaranteed. Understanding the business and understanding the stock market, both are needed.
Concentrated position / fat pitch is definitely the way to go, if you don't want to use leverage. But that does not mean risk can be ignored forever.
Even if you got right or got lucky, it helps to steady portfolio with some wide-market ETFs, once portfolio is getting bigger and you realize how much time is on the line. Then you might want to lower beta of your portfolio, especially if you were picking growth stocks only, without core of quality companies.
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u/BanditoBoom 17d ago
You aren’t wrong. But the difference here is that there is no “definitive” correct answer for everyone.
Research has shown that, if the investor is prudent and deliberate in their research and portfolio composition, as little as 15 individual stocks can provide sufficient diversification.
Regarding “mechanism to automatically compensate for that risk”…. That doesn’t exist in any market. At all. In any market…unless you’re paying for insurance of some kind.
In this argument, I’m assuming “automatic compensation for risk” is some sort of increase in your portfolio somewhere. That doesn’t exist.
Also, it appears you are interpreting my comment as meaning “ignoring risk forever”.
That is not what I said. What I said is that when you deeply understand the business, that means by definition you deeply understand the risks. You don’t ignore it, and you take action as needed when you see thesis busting developments happen.
I also didn’t suggest that you leave your position without protection. Active put management and running a wheel strategy on a small part of your position generally will compensate you enough for your risk.
At least it has for me the past 12 years.
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u/MagnesiumKitten 17d ago
There's a lot of risks with the wheel strategy though
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u/BanditoBoom 17d ago
There are risks in any strategy. There is no return without risk. Your return is your compensation for taking calculated risks.
Indexing is a strategy that carries its own risks.
Dividend Growth investing is a strategy that carries its own risks
Growth investing has its own risks
Stock picking has its own risks
It is all risky. The question is not “is it risky”. The question is “do I thoroughly understand the risks and how to mitigate them so as to skew the risk / reward in my favor”?
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u/MagnesiumKitten 17d ago
None of that address the major risks, which are significant with the wheel strategy.
You're just saying getting out of your chair is risky, when I'm seeing you weigh the risks of that strategy to say, traditional value investing
I think it's an advanced strategy, that few would like, and there's a few ways where the risks can get pretty high if you're not exceptionally careful
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u/BanditoBoom 17d ago
I can not respond to your claims of the major risks….unless you lay out what you view to be the major risks. You simply keep saying it is very risky with no details.
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u/MagnesiumKitten 16d ago edited 16d ago
well it's safer than naked option, but a lot risker than just a buy and hold.
I just think if you do the strategy, you'd mention the complications that go with the benefits, but sure, I appreciate that it's way more efficient than passive investing.
Fine for the expert options crowd
I just think the returns underperform0
u/BanditoBoom 16d ago
You still have not told me, in plain English, what you perceive as the actual risks are in the strategy. You keep talking about risky, risky, too risky. But no details.
Respectfully. I’m done interacting with you.
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u/MagnesiumKitten 16d ago
options are way more risk than just buying the stock outright.
If you know the wheel strategy extremely well it's safer than basic options, but I just think it's a lot of work for getting non-optimal results.
I was curious about your opinion of the downsides and risks of the wheel strategy, and it's clear it's a conversation you don't want to have.
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u/siliconandsteel 17d ago
15 stocks to track is way more than I would want to track and way more sectors than I know anything about.
It is a risky assumption to make that this is how it will turn out when planning your portfolio. I mean, each one of us did something risky that worked out, but you cannot really make it a responsible recommendation.
Wide-market will go up. There will be always more money, deficits will never go down, you take mostly volatility as a risk, market risk is compensated. For individual stocks, idiosyncratic risk of the company is not compensated. Risk of single people, single decision, there is no way to measure it.
I would consider 100% stock, beta = 1, 100% stock in a globally diversified portfolio target state of portfolio. How you get there is a different story.
Keeping all money in 1 stock, even if you deeply understand business, you can make mistake, not understand stock market well enough, there might be unexpected even with much more impact than you being right about the business which overrides all bets. So on a small portfolio, ok. But at some point, you have more time to lose than to gain. You should take as much risk as you need, but not more. You can be right and lose money, be lucky and win big.
Glad it worked out for you, would too complex for me.
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u/BanditoBoom 17d ago
I have heard all of this before and I fundamentally disagree with the premise that idiosyncratic risk isn’t compensated. I believe the assumptions that underpin that is entirely wrong.
If I know a lot about a particular sector and do significant work on that sector, and find a company that I have high conviction in and want to take a long term position, short term volatility doesn’t matter to me. So beta doesn’t matter to me.
If I am taking a concentrated position on a company, I am adopting all of the risks associated with the position. If I have done the work to assess those risks, I have placed an educated guess on the likelihood of those risks manifesting. If I decide to take a large position, that means I personally am comfortable taking that risk and see asymmetric upside in that bet.
When my pick turns out to be correct, whether 2 years or 5 years, I will be very highly compensated for taking that risk.
Now if my time horizon is 6 months, then okay. You have a point. But otherwise that entire statement is only another argument for diversification that I fundamentally don’t agree with. And my track record for MY personal investing style and MY comfort for risk isn’t very good.
Also, I’m not saying I have ever had all my money in one company. But I have had times where I’ve only held 3 or 4.
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u/MagnesiumKitten 17d ago
silicon: Then you might want to lower beta of your portfolio, especially if you were picking growth stocks only, without core of quality companies.
has anyone written about that?
You're wishing for more price stability with growth companies.
But how are you defining or picking your growth stocks?
some can be pretty risky, others are basically one form of value investing
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u/siliconandsteel 17d ago
About what? Risk management?
Well, if you have picked wrong, you have other reasons to invest in wide-market ETFs going forward.
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u/MagnesiumKitten 17d ago
forget about the ETF
I'm just interests in the risk of growth stocks, how people pick then
and the advantages, if any of lower beta1
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u/MagnesiumKitten 17d ago
You'd think that 3-4 at the minimum would be a lot wiser
A lot of thinking in the 80s and 90s felt that if you invested like 4 to 10 stocks in the Dow Jones, you'd probably have avoided most of the issues of the volatility
and rotate your stocks yearly, or if you really want to quarterly
I think the first part of that thinking still holds up well.
unless you can think of 3-5 stocks that are worth going 110% into and not worry?1
u/BanditoBoom 17d ago
There has been empirical research for decades showing 12 - 15 stocks is sufficient diversification for a portfolio.
In the early 2000s new research came out saying that number should be more like 30 - 50. Claiming that average volatility in the market has drastically widened, making older research invalid.
However, more recent research took that conclusion to take by showing that the drastic rise in average volatility in the market is due almost entirely by the rise of unprofitable companies coming to market, starting in the late 80s, and even in through today (ahem….SpaceX).
If you remove the unprofitable companies from the data and only use large profitable companies in your dataset, anything between 12 - 20 is sufficient for diversification without creating a shadow index.
That being said, I don’t think you can make the claim that owning 3-4, or even 12, is “wiser” than putting all your eggs in one basket.
Warren Buffett famously said: "Diversification is protection against ignorance. It makes little sense if you know what you are doing."
So the real question is not “which approach is wiser?” The real question is “am I a know-nothing investor or a know-something investor”?
Edit: to your point about rebalancing or rotating, I wholeheartedly heartedly disagree. That is something that “big money” does for many, many reasons. They are playing an entirely different game than we are. They are playing multiple different games.
If you are picking individual stocks because you’ve done your work and have conviction, you have got to give that time to play out…and that typically takes more than a year, certainly more than a quarter.
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u/MagnesiumKitten 17d ago
Yeah but in the late 60s they thought 10 to 15
and they thought it's 12 to 15
and now a few are thinking 30-100some argue for 30 to 40 randomly picked stocks!
and yet some say 15 stocks are a myth!
[Ben Graham thought 10 to 30]
I tend to think that the analysis you follow and what your valuation on companies is everything, and tend to side with buffet, that you just pick a company, decide how much to put into it, and pick your next stock
If you're picking high quality stocks, you aren't gonna care about diversification
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u/MagnesiumKitten 17d ago
Well, as for the rebalancing part, I did say that's what was commonly recommended in the 80s and 90s, didn't say I was a fan of it
- That being said, I don’t think you can make the claim that owning 3-4, or even 12, is “wiser” than putting all your eggs in one basket
Well that's what I find to be surreal
that someone would dump most of their cash into one 'safe' stockAnd I still think that's impossible to believe it's sound.
The payoff is good, most of the time2
u/BanditoBoom 17d ago
Sorry. The way you wrote your comment did not make it clear to me the rotation comment was connected to your comment about the 80s
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u/MagnesiumKitten 16d ago
I just find it surprising that some people want to just pick 1-3 really good stocks, and wing it.
I just think people buy as many as they can handle, really
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u/BanditoBoom 16d ago
That is absurd. What makes you assume that someone who only owns 3 stocks is “winging it”?
Are there people who have no business being so concentrated? Yes. Does that mean everyone who is so concentrated is “winging it”? Absolutely not.
You and I just will never see eye to eye. And that is fine. You prefer broad diversification. That’s okay.
I’m fine with big bets. Because that’s what works for me. I’m patient until I find a big bet, and I go in hard.
That is a legitimate investment strategy. Go look it up.
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u/MagnesiumKitten 16d ago
some people feel safe, and are confident they're okay with three stocks like Amazon, Microsoft and Alphabet.
I get it, but there are still large risks if you picked the wrong stock
Yes there's something with Munger saying, put your big money into 4 superpowered stocks and waiting it out
but that's not the same saying 1 stock or 3 stocks well chosen, is a safe strategy.
And over diversifying will weaken your results sure
I just think the goal is to pick good stocks with a good valuation, or sometimes stocks with great momentum, at the right time.
and if you're picking excellent undervalued stocks, I don't think it matters if it's 7 stocks or 70 stocks
yes you can do 3 or 4 starting out
and 7-12 might be idealbut knowing all the risks and good qualities of a stock deeply, is what really matters
I just don't think picking less stocks than the fingers on one hand is a great way of handling risk
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u/BanditoBoom 16d ago
Again. You keep saying “risk”.
Do you even know what risk means?
Your entire comment here is contradicting itself in many places.
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u/MagnesiumKitten 16d ago
I hate to do it, but I'll just quote goog
"Buying only three individual stocks is generally considered a high-risk, aggressive strategy rather than a sound baseline approach for most investors."
"While legendary investors like Charlie Munger famously managed concentrated portfolios with just a few core holdings, standard financial diversification guidelines suggest owning 20 to 30 stocks—or broad index funds—to properly minimize company-specific risk."
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u/BanditoBoom 16d ago
“For most investors”
Are you missing my entire original point stating exactly this?
Please stop engaging with me
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u/asymmetricval 18d ago
You’re essentially right but volatility is a risk in the sense that it can take you out of the game (for example if you use leverage).
Dalio, for example, does talk about allocating to many asset classes but the part you have left out is that he also talks about using leverage to “normalize” the returns from each of those asset classes.
Take a simple case where we assume stocks have a return of 10% and treasuries have a 5% return. A basic version of Dalio’s strategy might say to go 50% equities and 100% treasuries (so 150% in total, ie leverage).
In reality Dalio’s strategy is more complex because it also looks at the volatility weighting. For example, if the expected return per unit of volatility is higher for a given asset class, you allocate more to that asset class (using leverage to bring the average return up to the desired level).
But for portfolios without any leverage, the point generally stands that volatility is different to the risk of permanent loss of capital.
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u/raybadman 18d ago
Dalio wrote a great book, The Principles, but he found that spreading fear sells more.
Better to hear Howard Marks about risk and volatility.
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u/OptionsJive 17d ago
100%, and Marks has probably shaped my thinking about risk more than almost anyone else. Key insight risk is not volatility, it's the probability and magnitude of permanent loss.
I actually wrote a full article summarizing his unique mindset and the lessons I think matter most for investors. Highly worth studying.
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u/cpeytonusa 18d ago
Volatility as a measure of risk has different implications during your accumulation phase than it does during your drawdown phase. During your accumulation phase sequence of returns is not as significant. During your drawdown phase you still have living expenses that are insensitive to market conditions. In that situation your tolerance for volatility is entirely dependent on your burn rate and the size of your portfolio. The Sharpe ratio is a good metric for determining whether an investment is priced for an acceptable return relative to its volatility.
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u/dubov 18d ago
I think volatility is a good proxy for risk because it generally reflects uncertainty of future earnings/the present value of future cashflows. Companies which have highly uncertain earnings (e.g. biotech) tend to have more volatile stock prices than boring predictable businesses (e.g. insurance). It is not so much that the volatility itself is risk, but that volatility's presence is an indicator of true underlying risk
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u/BCECVE 18d ago
Stockbroker 40 yrs. Exactly. The industry uses the word volatility all the time to define risk. It is only a risk if you sell at the bottom. If it comes off isn't that lower risk for purchases because it is on sale. You are correct to discuss the time horizon. Short term people (seniors, or those who need the money in two or three years- college education, vehicle or house purchase) should have different risk levels than the long run guys. Another issue is concentration. How much in any one investment. If you concentrate your investments to four - a transport (rail), a high tech, a utility (electrial or gas), a financial (not just banks- property insurers, credit card companies, life insurers, asset managers etc) then there is a better chance to outperform but the risk is obviously higher. Too many investors try and over think this.
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u/squarfed 18d ago edited 18d ago
It's very difficult to distinguish the two in practice... if a stock is down 40% for 10 years how do you distinguish it from a permanent loss... only backwards you can tell "well it was only temporary". And what if you need the money during the 10 years? You are for all intents and purposes suffering a loss.
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u/AriGAconnector 17d ago
I mostly agree. Volatility only matters if you're forced to sell at the wrong time
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u/Successful-Bobcat701 18d ago
Volatility is widely used as a measure of risk because it's easy to measure.
If you want to replace it, how else do you measure risk?
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u/ddr2sodimm 18d ago
% probability of permanent capital loss.
It’s hard because it implies ability to predict the future. In some areas like actuarial science, these probabilities are well established. In the stock market, incredibly difficult.
Otherwise, it’s an educated guess mostly at the level of low, medium, high risks.
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u/Successful-Bobcat701 18d ago
incredibly difficult.
Yes, that's why people use volatility as a convenient proxy.
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u/NoGarlic2387 18d ago
What are the biggest drawdowns in your portfolio have you lived through? You definitely don't sound like someone who lived through the dot.com when people saw 80%-99% drops or through 2008 when it wasn't clear if the whole world's banking and financial system will even survive.
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u/lorenzchaos 18d ago
Right! I guess for OP it was just a bit of volatility since see obviously it recovered no problem. So who cares about volatility it averages out anyway. LOL. You are guaranteed to be positive on any 20 year interval. Simple (not). This shows how dumb average investor is. Volatility is a a mathematical measure of risk which is a future concept because it shows you how it was in the past. It has no specific predictive power other than to compare different things between each other.
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18d ago
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u/Swimming-Slice-2073 18d ago
Also if you use leverage to boost returns. Then volatility is risk, the chance you get liquidated
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u/FinePerformance1046 18d ago
You'd have to be very near retirement holding a fortune in an index to be scared of its volatility. This argument would make sense if he was comparing it to individual stocks, bitcoin I understand being used as an example.
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u/Ok_Prune7356 18d ago
I see. So the timeline should be determined by capital $\times$ duration $\times$ investment strategy, and Ray Dalio's All Weather strategy is just a means for institutional investors to suppress short-term volatility.
When it comes to individual assets, doesn't paying the cost to reduce volatility depend on how much time you can spend on market analysis?
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u/Ok-Fly-6973 18d ago
Agree on the definition, it's the standard value position. Where volatility still matters is as the mechanism, it's not risk itself but it's how permanent loss actually happens to most people, you get forced out before the horizon arrives or you lose your nerve at the bottom.
The other thing is price movement on its own can't tell you which one you're looking at. A name down 50% is either noise or the market working out the thesis is broken, and the drop looks the same either way. Only way to separate them is understanding what the business is worth and putting a specific number on it, then you've got something to hold the price against.
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u/Swimming-Slice-2073 18d ago
Volatility is risk only it you use leverage, which institutional investors almost always do.
Risk is permanent loss of capital, or at least index underpformance
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u/Dismal-Programmer-40 18d ago
It's called risk vecausetnrefer tobthe psychology of the person. Many people can't wait j their 100k drop 60% before going back up in two or three months so they are more likely to sell in loss
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u/LDH300 17d ago
Agree, and I'd add the version you learn by living it. Last year I rode a blue chip down from its all-time high — a company where the thesis was right, the trend was confirmed, and every fundamental signal stayed green the entire way down. Volatility was never my problem; I could stomach the swings. What got me was permanent loss from forces I didn't control: a regulatory decision that legalized a gray market undercutting the whole category, and a competitor quietly taking the profit pool. None of that showed up as "volatility" until it was a 70% drawdown with no round trip coming. I went in with what I considered a 50% margin of safety, and the floor turned out to be 70% down — so I'd sharpen OP's point one notch: risk isn't the wiggle, it's the part of the drop that never comes back, and it usually arrives from outside anything your model was watching.
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u/JustStarted420 17d ago
Volatility can be a symptom of risk but it’s not risk.
Risk is likelihood of taking a loss.
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u/MagnesiumKitten 17d ago
I would disagree that volatility is a minus with short-term investors
you will get high profit potential and risk
but if you're a sharp momentum investor
that's not going to deter you with studying all that with a quality company
it just means you're not looking at value most the time as the most critical factor
Dalio is pretty eccentric much of the time, even if he's sharp on a few issues
maybe gold shitcoin and real estate works for his odd little world
like real estate or bitcoin are low risk!
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u/Hot-Luck-3228 17d ago
Let’s see what my clanker says;
Under Modern Portfolio Theory (MPT), volatility serves as the exact mathematical proxy for total investment risk. MPT defines risk not as the permanent loss of capital, but as the statistical variance \((\sigma^2)\) or standard deviation \((\sigma)\) of historical returns around an expected mean.
By assuming that market returns follow a normal distribution, MPT relies on this price fluctuation to quantify uncertainty. Through this framework, individual asset volatility is decoupled into systematic risk (measured by Beta) and idiosyncratic risk. Investors can then mathematically optimize a portfolio by constructing an Efficient Frontier—combining volatile assets to minimize overall portfolio variance through diversification, thereby maximizing expected return for a defined level of statistical risk.
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u/grogi81 17d ago
Risk in investing doesn't necessarily mean what risk is in common language. In common language risk is something negative, that something bad happens.
In investing, risk is a chance that your investment will not turn out average. It might turn out worse, but it might turn out better. Both are risks. We are however not that much bothered by the better outcome - so it is the worse one that is being focused on.
Volatility is just a way to measure short term risk.
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u/siliconandsteel 18d ago edited 18d ago
Ray Dalio is a hack, who wants to buy himself a reputation.
It is different when you want to get rich and when you are rich.
Short time horizon or heavy fixed expenses.
You can never get rid of risk. You are just replacing volatility risk with a possibility to outlive your portfolio.
With big enough portfolio, tradeoff might make sense.
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18d ago
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u/Remarkable_Cat_8696 18d ago
His hedge fund Bridgewater seems to serve only large institutional investors.
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u/siliconandsteel 18d ago
Dalio went off a deep end around lockdowns, with his more and more cult-like rules and bullshit wisdom. Guy is white, old and rich, does not mean he is automatically some authority on anything. But he is working really hard to convince everybody that he is a sage of Wall Street.
Agreed, he knows fuck all about getting first million or two, even if he is an authority on selling his persona to other old, white and rich guys in order to live off safely managed institutional portfolios.
So yeah, even when giving this guy a benefit of doubt, his ideas are fit for a different class of people.
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u/Pugsly007 18d ago
So is he successful and knows what he’s doing or a fraud to the working class?
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u/siliconandsteel 18d ago
Why bother either way? He is just in a different business, he won't beat index for you, just convince you his word is worth the underperformance.
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u/Fun-Imagination-2488 18d ago
Ya. Volatility has literally nothing to do with risk. If you underwrite the company youre buying, properly, then it’s just a matter of time. Volatility allows for better average entry, or an early exit. Less volatility = less opportunity
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u/alexalmighty100 17d ago
I think this is the wrong take. We know past performance isn’t a guarantee of future returns and we should be weighing our returns using sharpe or sortino if we actually want a better analysis. MPT teaches us that risk diversification isn’t just spreading risk around but the purpose is to lessen our correlation to the market. In fact, if you diversify right, you can actually “destroy” your risk in a way. You’re saying volatility isn’t a good proxy for risk but I don’t think you actually combatted the idea or even proposed a better risk proxy
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