Volatility and risk are not necessarily the same
The most accepted financial theory relates portfolio’s risk to its short-term volatility. Under this premise, a very volatile portfolio has a higher risk. The investment industry understands risk as how difficult a certain path is to success rather than the end result. A comfortable path is perceived like less risky; however, it turns out to have a poor profitability. Some investors have a different perception: for example, Warren Buffet considers market falls as great opportunities to invest. In this way there’s discrepancy among investors: some outstanding investors don’t associate risk with volatility. Instead, they relate it with a loss of opportunity. The risk is not to achieve adequate or optimal performance for our portfolios.
The real risk is not getting the expected performance.
Recently, a few authors that supported the theory of “Behavioral Portfolio Management”, tried to solve this problem. They define risk as the chance there is of a lack of performance. According to their point of view, creating a portfolio that seeks to minimize short-term volatility is a huge mistake because; ultimately, this may lead to the opposite result: increased risk. They believe the real risk is producing mediocre returns for their customers.
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It will only be possible to apply a complete long-term vision once the investor has mentally overcome these barriers. Investors with a more mature vision could not be impacted by the industry standards: these standards suggest that portfolios, which minimize short-term volatility, are built putting the long-term returns achievement before anything else. BPM theory describes this as the huge mistake: putting emotions at the core of the long-term horizon portfolio’s designing process.
Such emotions often cause many investors to leave the market after violent falls or increased volatility. However, some studies prove just the opposite: this is the right moment to gain positions. Higher returns are only expected after great falls.
It is relatively easy to build portfolios with high performance, if certain principles are accepted. Moreover, it can be much more complicated taking into account emotions.
Although, we commonly think about the world of finances as being more similar to physics, it is really colser to sociology. Anticipating the short-term is impossible, so when one overcomes these barriers it means they are able to control their emotions.
Our diversified portfolios are based on investment strategies geared towards “calmed” investors. In addition, their dynamic management also involves some protection in times of large corrections. Even so, the goal is to achieve optimum returns in any market.
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