When we talk about investing, one of the most mentioned—and also most misunderstood—terms is risk. From professional managers to individual investors, everyone wants to avoid, minimize, or manage it. But do we really know what we mean when we talk about risk? Is it simply synonymous with volatility? Or is it something deeper, more strategic, more human?
In this article, I propose a reflection: risk is not what many believe. Volatility, drawdown, or the Sharpe ratio are useful, yes. But the real risk is related to not reaching our vital goals. And understanding this can radically change how we invest and how we live our relationship with money.
1. Risk from a Technical Perspective
In finance, the quantification of risk has historically been associated with objective metrics. Let’s look at the most common ones:
▸ Volatility:
Volatility is the best known. It measures the standard deviation of an asset’s returns. In other words, how much it fluctuates. If a fund goes up or down 10% frequently, it is considered more volatile—and therefore more “risky”—than one that moves only 2%.
▸ Sharpe Ratio or Risk-Adjusted Return
The Sharpe ratio measures how much additional return an investor receives for each unit of risk (volatility) assumed. It is calculated as the annualized return (APR) in excess of the risk-free asset divided by the annualized volatility. The higher, the better.
A simplified version consists of dividing the APR directly by the annualized volatility, omitting the risk-free rate adjustment. In practice, it gives a very similar approximation.
These tools are valuable. They help us compare assets, build portfolios, and make decisions based on quantitative data.
We can clearly see how the concepts of return, volatility, and Sharpe ratio manifest in the evolution of different inbestMe portfolios. In the upper chart, we observe that the portfolio with the highest APR (+7.6% of profile 10) is also the one with the highest annualized volatility (12.7%). Meanwhile, the savings portfolio, with barely 0.5% volatility, achieves an APR of 2.9% and a very high Sharpe of 4.4. In other words, although the savings portfolio is excellent, if we rely solely on volatility/Sharpe ratio, it might be insufficient to achieve a long-term goal. For that, we must accept more volatility, which will allow obtaining higher APRs and more guarantees of beating inflation.
▸ Drawdown:
Drawdown (maximum drop) reflects the percentage loss from a peak to a trough. It is useful because it shows the worst historical experience of an investor who entered at the worst time. Therefore, it quantifies “risk” or maximum fear in percentage terms associated with that investment.
In the upper chart, we see that the maximum drops during this period are higher (-6%/-2%) in portfolios with higher risk profiles (6 and 10), being very low (-0.5%) in profile 2 or zero in the savings portfolio. Again, these are temporary maximum drops.
There are more complex and sophisticated metrics, but all share a limitation: they are partial representations of a much richer reality. Like a black and white photo of a world full of nuances.
2. The Trap of Confusing Volatility with Permanent Loss
Technical measures are different faces or indications of risk that are useful for comparing different investments.
But when volatility is perceived as synonymous with risk, the result is usually fear. Market drops of 10%, 20% (which by the way are common) or more provoke intense emotional reactions: doubts, impulsive sales, abandoning strategy… If it is understood that this is normal, it can be understood that it is not necessarily “risk”. It is undoubtedly a feeling of “discomfort” that must be learned to tolerate to achieve some return.
Volatility is not permanent loss. It is temporary fluctuation.
An example: the MSCI World index has had multiple drops of -20% or more over the last decades. But it has also multiplied its value several times. Anyone who has maintained a diversified portfolio in global equities over 20 or 30 years has probably seen their wealth grow despite (or thanks to) that volatility.
3. The True Nature of Risk
If we accept that volatility is not the enemy, what is then the real risk?
▸ Permanent capital loss
Investing in non-diversified assets, without understanding them, or in highly speculative projects can lead to total loss. This is a true risk. History is full of examples: tech bubbles, real estate, unfounded cryptocurrencies…
Beyond technical measures, the true risk is subjecting our investments to a permanent or total capital loss.
Precisely, the portfolio proposals made at inbestMe are endowed with maximum diversification to practically eliminate the potential for permanent loss.
▸ Not achieving your vital and financial goals
Money is a means, not an end. We invest to meet goals: retire safely or with an acceptable standard of living, pay for our children’s education, buy an adequate home, achieve financial independence… If investments don’t allow reaching these, even if they are “stable,” they are not fulfilling their purpose of helping with vital goals, often intrinsically linked to financial ones. In other words, money can be left in the bank out of fear of volatility. But it is very likely that many financial goals will not be achieved. Moreover, leaving money uninvested exposes it to another risk: inflation, which erodes purchasing power.
Not achieving financial goals is the most important risk to avoid. That is why inbestMe encourages investment by objectives and the segregation of different financial goals, associating each with its desired return target, while accepting the temporary (not definitive) loss to be tolerated.
▸ Making bad decisions at critical moments
Risk is also within us. In our lack of emotional preparation. Selling in panic, buying out of greed, or abandoning a solid plan due to emotions. This type of risk doesn’t appear in any chart, but it is one of the most destructive.
4. Volatility: The Price of Opportunity
The paradox is that without volatility, there is no return. It is that uncertainty that generates the risk premium rewarding long-term investors. In other words, volatility is the price paid to access superior returns from financial markets.
When this is understood, the relationship with risk changes. It is not about eliminating volatility but living with it and managing it intelligently:
- Diversification
- Appropriate time horizon (the longer, the better)
- Recurring contributions (preferably automated)
- Alignment with personal goals
And ultimately, when understanding that volatility does not imply permanent loss but temporary opportunity, it can even be reversed:
Dips become ideal moments to contribute more. Opportunities to improve future returns. A well-designed portfolio not only tolerates volatility, it requires it.
5. Manage real risk
Investing is not about avoiding shocks but moving forward steadily. Metrics like volatility or Sharpe are useful compasses but should not make us forget the map: our goals. A very useful complementary tool is using a Goal Forecaster that facilitates financial planning and goal achievement.
Managing risk, properly understood, is not about fleeing the market every time it shakes. It is about focusing on achieving our goals, having the emotional capacity to sustain it in difficult moments, knowing they are temporary, and the humility to know not everything is under our control.
The real risk is not in charts or numbers. It lies in not knowing why and for what you are investing, and understanding that volatility is part of the path to success.
