What is investment risk? Risk is generally defined as the chance that an investment’s actual return will be different than expected. Risk includes the possibility of losing some or all of your original investment.
Many definitions of risk go on to explain that risk can be measured by calculating the standard deviation of the historical returns or average returns of a specific investment. Even if you took a statistics course at university, you might find it difficult to apply that concept to a specific investment.
To better understand the concept of investment risk, it may be help to consider some familiar investment instruments. Government bonds and guaranteed investment certificates are generally considered to be risk-free investments. Investors have full faith that the principal and interest will be paid in full and in a timely manner.
The riskiest investment most Canadians are likely to make is buying a lottery ticket. When you buy a lottery ticket, the potential return is huge. However, because the odds of you winning are many millions to one against, it is very likely that you will suffer a total loss of your initial investment.
The investments that most Canadians purchase fall somewhere between these two extremes. Consider shares in a high tech startup: the business could go on to become the next Apple, Google or Facebook. If it did, the return to investors might be hundreds of times their original investment. But if the business fails to sell enough of its product or service, it could go bankrupt and the stock price decline to zero. Not as risky as a lottery ticket, but still risky.
On the other hand, consider a large cap stock such as TransCanada. The company recently wrote off $2.5 billion as a result of the US government’s refusal to approve its Keystone XL pipeline project. But the company has not gone out of business. In February, TransCanada announced an 8.7% increase to its quarterly dividend to $0.565 per share. While its stock declined from a 2015 high of $57 to a low of $41, it has since recovered to $50.
Update Nov 20, 2017 – Nebraska approves alternative route for TransCanada’s Keystone XL Also, TransCanada’s stock is now trading at $63.50 and its quarterly dividend in now $0.62 per share.
So holding a large cap stock such as TransCanada entails some risk. But the level of risk is significantly less that buying a lottery ticket or small cap stock. And here is the key point: the risk is not that you will lose all of your investment as you likely will with a lottery ticket or could with a small cap stock. The risk is that your funds might not be available when you need them. But time can mitigate much of that risk: if you don’t need your money today, you can afford to wait for the price to recover. And in the case of TransCanada, you continue to receive 3.9% annually in dividend income.
At Sprung Investment Management, our portfolio management approach is based on managing risk. How do we do that? We work with clients to match our value-based investment management approach to their goals and risk tolerance. Based on the client’s situation, we will determine an appropriate mix of equity and fixed-income investments. On the fixed-income side, bonds offer clients the potential for regular income, preservation of capital, portfolio diversification and a hedge against economic uncertainty.
With over three decades of experience, we have found that our three-part value investing strategy is the best way to reduce risk and volatility and earn consistent returns over time. Our diligent, patient and opportunistic approach has served our clients well, through good and bad markets:
- Appraise the intrinsic value of each company over a business cycle;
- Seek long-term growth of capital by investing in companies that we perceive to be mispriced;
- Utilize a margin of safety to promote return of capital…not just return on capital.
Why does our value investing approach work? The prices of well-established, high-quality stocks tend to rise over time as the companies create value for shareholders. Stocks touted by brokers and the media often rise to extreme highs in expectation that they will meet or exceed their short-term earnings forecasts. However, they can decline dramatically when they fail to meet those forecasts.
What is Successful Investing? Learn more here>>
The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.