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Do you speak riskese? Residents of China
speak Chinese, citizens of Japan speak Japanese, lawyers speak
legalese and top-notch investment advisors, casino statisticians,
and insurance underwriters speak riskese. Riskese is the language
that’s used to discuss topics of risk, return, time,
and correlation.
Risk, return and time are all intertwined.
Higher exposure to the right risk factors leads to higher
expected returns. The longer you hold a risky investment,
the more likely you will obtain the long-term expected return.
However, because of “random drift,” risk is very
unpredictable in the short run, but it can be quantified far
more accurately than gut feelings and intuition in the long
run. For example, you can flip 10 heads in a row with a coin,
but there is still a 50/50 chance that you will flip heads
the next time and in the long run. Remember that if there
is no risk, there is no reason that you can expect a higher
return than Treasury bills, which have paid an annualized
return of 3.8% per year for the last 70 years, just 0.5% over
inflation.
High risk exposure is like a scream inducing
roller coaster, with soaring highs and stomach churning lows.
On the roller coaster, the greater the ups and downs, the
greater the returns... measured in thrills. The same thing
applies to investing. However, not everyone has the “capacity”
for such “exposure” to risk. In this step the
concepts of risk, return and time will be explained.
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