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I've seen previous questions about risk here and here, as well as read some stuff in books about similar ways of assessing risk.

However, as discussed in one of those questions, a lot of the information you find about risk either explicitly or implicitly operationalize it as volatility, even though this doesn't really fit with the practical definition of risk. That is, when investing for the long term, you don't really care how much the investment goes up and down overall, you just care about: A) what is the likelihood that you will permanently lose money; B) what is minimum return you can count on with X degree of confidence after a period of Y years, perhaps relatively to some baseline reflecting "what anyone can expect" (e.g., the overall pace of the economy). Although some answers to that question acknowledge this, they don't provide many sources of concrete information about where to get data/advice that uses alternative notions of risk.

In the terms you usually read about, something like the S&P 500 is considered a risky investment relative to money markets or bonds. But in the terms I'm talking about, the S&P 500 would be considered extremely low risk, because: A) everyone believes that the S&P 500 cannot permanently lose value except unless the global economy suffers an irremediable collapse; and B) over a long enough time horizon, it's been virtually guaranteed to earn decent returns relative to alternative investments.

Also, from this perspective almost any fund tracking a major index is likewise perceived as very low risk: even though, say, small caps may be perceived as riskier than the S&P 500, still no one believes that the entire small cap sector of the economy is going to crash and burn absent WWIII. Therefore, if you're trying to decide among different index funds, the question becomes, why would you not invest everything in the "riskiest" sectors (by traditional measures), as long as it's believed that those sectors, even if they crash spectacularly, will always recover.

A related piece of the issue is that, even if you have a short time horizon, there are typically things you can do to stretch it a bit if something bad happens. It's not like you have to stick to your plan of selling all the stock on January 2 even though the market just crashed. For instance, if you had been planning to shift your IRA into bonds in preparation for retirement, but then the market goes down, you can adjust your withdrawal rate, stretch the bond shift out over time, etc.

So what I'm wondering is, are there resources available for the individual investor that treat risk in these terms? What I'm looking for is things that discuss, for instance, allocation among large-scale asset classes (US stocks, developed world stocks, emerging markets, REITs), in terms of questions like "If you invest $X in index A and index B, what is the likelihood that, even after N years, index A was still underperforming index B?" You would then decide what threshold of this risk measure you were comfortable with. Such resources would ideally also include systematic approaches to "hedging" your time horizon as I described above, e.g., by saying that if you beleve the market just took a dive but you still need to sell stocks, you should adjust your selling behavior in such-and-such way to minimize the damage.

Most books/articles/fund info I can find online either parrot back the same generic risk info (e.g., stocks vs. bonds), use volatility measures of risk, or don't even explicitly say how they're assessing risk (or some combination of these). So I'm wondering where someone can go to get information about risk that is actually geared towards making decisions based on expectations about outcomes.

In a nutshell: how can an individual investor evaluate diversified investments (not individual stocks, but say index funds in different sectors) in a manner consistent with practical notions of long-term risk of the form "I want to divide my money among funds A, B, and C, and minimize the chances that after 30 years I will not have earned a return of at least X%"? By increasing X you may also have to increase the minimum chance of failure, and that would be the measure of risk that you take on to achieve that higher return.

  • One way in which volatility translates into risk is that you will still liquidate the asset at some specific point in the future, and higher volatility means a higher chance that its price will be at a low point at that time. – Michael Borgwardt Apr 24 '14 at 7:08
  • So you're looking for investment risk ratings in terms of chance-of-ruin rather than volatility? The problem is that the math for volatility-based risk is very well researched, so quants can work with it, so quants do work with it [and little else]. You may think this is the tail wagging the dog; I couldn't disagree... – AakashM Apr 25 '14 at 15:47
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Generally investing in index-tracking funds in the long term poses relatively low risk (compared to "short term investment", aka speculation). No-one says differently.

However, it is a higher risk than money-market/savings/bonds. The reason for that is that the return is not guaranteed and loss is not limited. Here volatility plays part, as well as general market conditions (although the volatility risk also affects bonds at some level as well). While long term trend may be upwards, short term trend may be significantly different. Take as an example year 2008 for S&P500. If, by any chance, you needed to liquidate your investment in November 2008 after investing in November 1998 - you might have ended up with 0 gain (or even loss). Had you waited just another year (or liquidated a year earlier) - the result would be significantly different. That's the volatility risk.

You don't invest indefinitely, even when you invest long term. At some point you'll have to liquidate your investment. Higher volatility means that there's a higher chance of downward spike just at that point of time killing your gains, even if the general trend over the period around that point of time was upward (as it was for S&P500, for example, for the period 1998-2014, with the significant downward spikes in 2003 and 2008).

If you invest in major indexes, these kinds of risks are hard to avoid (as they're all tied together). So you need to diversify between different kinds of investments (bonds vs stocks, as the books "parrot"), and/or different markets (not only US, but also foreign).

  • It's still not clear to me, though, how big such downward spikes must be to erase, say, 10 years of gains, or whether volatility measures accurately assess that. However, that's neither here nor there, because my question here is less about the relative merits of the two ways of assessing risk, and more about where I can go to find evaluations of different investments that explicitly use an expected-outcome approach to risk. – BrenBarn Apr 24 '14 at 17:54
  • @brenbarn I'm not sure I understand what you're saying... Are you looking for information on how to predict the future? – littleadv Apr 25 '14 at 2:28
  • I suppose you could put it that way. One of the questions I linked to mentions alternative risk assessments like risk of permanent loss and Monte Carlo simulations. I can go to Morningstar and find the standard deviation and other volatility-based risk measures for funds. Where can I go to find risk assessments that are based on alternative conceptions of what risk is? – BrenBarn Apr 25 '14 at 18:03

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