Understanding Risk: The Most Misunderstood Word in Investing

Most investors want one thing: high returns with low risk. But very few can define what “risk” actually is.

• Is it the chance of losing money?
• Is it volatility?
• Or is it something deeper — like not reaching your financial goals on time?

In the world of investing, understanding risk is more important than understanding returns. Because while returns are uncertain, risk is a constant — and often, a silent one.

Why Understanding Risk Is Crucial

Every investment decision is a trade-off between risk and reward. Yet, many investors focus almost entirely on the return side of that equation. This imbalance often leads to poor decision-making — whether it’s chasing trending stocks, panicking during market corrections, or investing in products without fully understanding the downside.

Example: In 2020, many investors rushed into high-yield debt funds without fully considering credit risk. When some of these funds faced defaults or delays, the consequences were immediate — but the risks had been building up quietly for months, if not years.

Risk is not always visible upfront, but it always exists.

What Is Risk — And What It Isn’t

Risk is often confused with volatility — the up-and-down movement of prices.

But volatility alone doesn’t capture the full picture. For a long-term investor, temporary price fluctuations may not matter much. What matters more is:

• The probability of permanent capital loss
• The uncertainty of future outcomes
• The risk of not meeting your financial goals

For instance, parking too much money in a low-return fixed deposit may seem “safe,” but over time, it could expose you to inflation risk — the loss of purchasing power. In this case, avoiding market volatility may actually increase your overall risk.

Types of Investment Risks Every Investor Should Know

• Market Risk: Losses due to overall market movements. Cannot be fully eliminated.
• Credit Risk: Risk of default by bond issuers or borrowers.
• Liquidity Risk: Difficulty selling investments without price impact.
• Concentration Risk: Overexposure to a single stock, sector, or asset class.
• Inflation Risk: Erosion of real value due to rising prices.
• Behavioral Risk: Emotional decisions like panic selling or overconfidence.

How Investors Often Misjudge Risk

• Chase past returns, assuming what worked before will work again
• Ignore drawdowns, focusing only on average returns
• Overestimate safety in complex or opaque products
• Confuse guarantees with low risk

For example, a fund offering 12% annual returns may seem attractive, but unless you understand how those returns are generated, you may be taking on far more risk than intended.

Suitability matters more than performance.

Conclusion: Risk Cannot Be Avoided, But It Can Be Understood

No investment is risk-free — not even cash.

The key is to understand the nature and magnitude of risk, and how it aligns with your goals, time horizon, and risk appetite.

By focusing on risk-first investing, rather than return-chasing, investors can build more resilient portfolios and avoid unpleasant surprises.

Next in this series: How to quantify risk using simple tools and align investments with your personal risk profile.