Staying in the Game: A Better Way to Think About Risk
Most investors say they understand risk, right up until they feel it.
Risk rarely arrives with an announcement. It shows up as a headline you did not expect, a market move that feels bigger than it should, or a portfolio statement that suddenly looks unfamiliar. The uncomfortable truth is that the market’s job is not to make you feel safe. Its job is to price uncertainty in real time. If you want to invest well over decades, you need a definition of risk that holds up not only when things are calm, but especially when they are not.
That is why we start with a simple idea: investing is not primarily about returns. It is about risk. Returns are the reward. Risk is the cost. Portfolio construction is the craft of choosing which risks are worth paying for, and which risks are not.
Understanding risk starts with a definition
Ask ten investors to define risk and you will usually hear one of two answers. Some will say risk is volatility, the uncomfortable up and down movement of account value. Others will say risk is losing money, meaning a permanent loss of capital. Both perspectives make sense. Volatility is visible, emotional, and immediate. Permanent loss can be quieter, because it can happen slowly through weak businesses, overpaying for assets, or failing to keep up with inflation.
Neither definition is complete on its own. Volatility can be temporary and survivable. Permanent loss can be irreversible. And both can become dangerous when they push you into the risk that sits beneath many bad outcomes: making the wrong decision at the wrong time.
A more useful working definition is this: risk is the probability and magnitude of failing to meet your financial objective. In other words, risk is not just what a chart looks like. Risk is what prevents your money from doing what it is meant to do in your life.
Preparing for the unexpected
One mindset we often return to is the idea of preparing for what you cannot predict. Jamie Dimon has frequently emphasized resilience and the importance of not assuming the future will look like the recent past. The practical lesson for individual investors is not to forecast every shock. It is to build a plan that can keep operating through a shock.
In portfolio terms, that resilience usually comes from a few plain principles: maintain sufficient liquidity so you are less likely to become a forced seller, avoid hidden concentrations that only reveal themselves in stress, and assume that correlations can rise when markets are under pressure. The goal is not to avoid every drawdown. The goal is to reduce the chance that a drawdown turns into a permanent detour from your plan.
In Thinking in Bets, Annie Duke reframes decision making under uncertainty. A good process can still produce a disappointing outcome, and a bad process can still get lucky. Markets work the same way. The takeaway for investors is to focus less on being right and more on having a repeatable process for weighing odds, updating beliefs as new information arrives, and sizing exposure so that being wrong does not become catastrophic.
Risk is the core element of portfolio construction
A portfolio is not simply a list of investments. It is a system of exposures designed to behave a certain way across different environments. It should answer questions that matter more than any market forecast. How much downside can you tolerate financially? How much downside can you tolerate emotionally? Where do you need liquidity, and when? What risks are you being paid to take, and which risks are uncompensated?
When those questions are not answered, investors often end up with a portfolio that looks fine in calm weather and breaks down in a storm. The goal is not to eliminate risk. The goal is to choose the right risks, diversify across them, and size them so the portfolio remains functional through uncomfortable but inevitable periods.
Index trackers and the confidence band illusion
Index funds and ETFs can be powerful tools. They are often low cost, diversified, and simple. For many investors, they can reduce single company risk and help maintain discipline. They can also create something subtle: an emotional confidence band. When you own a broad index, day to day moves may feel more tolerable, and that smoother experience can be mistaken for lower risk.
It helps to name a few trade offs. First, an index approach typically captures upside in proportion to a company’s weight in the index. That can be a feature or a limitation depending on your objectives. Second, indices can become top heavy over time. You may own hundreds of holdings, but the economic exposure can still be driven by a handful of large names or sectors.
The point is not that indexing is good or bad. The point is that the range of outcomes is defined by the tool you choose. In our portfolio design, we aim to build intentional guardrails through diversification, position sizing, and thoughtful positioning, so that no single risk dominates the outcome.
Price, cash flow, and what risk really means
Even if markets are not perfectly efficient, price still reflects a story. The market price of an asset embeds assumptions about future cash flows and the riskiness of those cash flows. When you buy something, you are implicitly saying one of two things: either the cash flows will be better than what the current price implies, or the risks to those cash flows are lower than what the current price implies, or some combination of both.
This is why valuation and risk cannot be separated. Risk is not only volatility. Risk is the chance that forecasted cash flows do not arrive, arrive later than expected, require more capital than expected, or get discounted more heavily because interest rates rise, spreads widen, or liquidity becomes scarce.
Different kinds of risk, and why the distinction matters
Investors get in trouble when they treat risk as one single thing. In reality, it is a set of risks that show up at different times and require different tools.
Volatility risk is the day to day movement of prices. Drawdown risk is the depth of the decline from peak to trough. Fundamental risk is the business or issuer failing to deliver. Valuation risk is paying too much relative to realistic cash flows. Liquidity risk is needing to sell when markets are unwilling to provide a fair price. Interest rate risk is the sensitivity of assets to changes in discount rates. Inflation risk is losing purchasing power quietly. Concentration risk is letting one theme dominate the outcome. Sequence of returns risk is the danger of poor timing, especially when you are withdrawing. Behavioral risk is abandoning a plan during stress.
Once you see risk this way, portfolio construction becomes less about finding the perfect idea and more about building a system that can live through many environments.
A probability framework for educated decisions
A useful way to apply this is to treat investing as a probability exercise, not a prediction contest.
Start by defining the objective and constraints, such as time horizon, liquidity needs, and taxes. Identify a few plausible scenarios that could matter, rather than trying to forecast one precise future. Build exposure with different payoff profiles, so the plan is not dependent on a single outcome. Size positions by uncertainty, not by conviction alone. Monitor what would change the odds, and try not to overreact to noise.
Bottom line
Risk is not something to avoid. It is something to choose. The best investors are not the ones who never feel uncomfortable. They are the ones who design portfolios where discomfort is less likely to become a decision point. The goal is not to eliminate uncertainty. The goal is to stay in the game long enough for good decisions to compound.
Disclosures
This material is provided for informational and educational purposes only and does not constitute individualized investment advice, a recommendation, or an offer to buy or sell any security. Any references to market conditions, tools, or individuals are for general educational discussion. Investment strategies involve risk, including the possible loss of principal. Diversification and asset allocation do not ensure a profit or protect against loss in declining markets. Forward-looking statements and opinions are subject to change and are not guarantees of future results. Past performance is not indicative of future results.
