Many investors focus on returns, and during bull markets they make back most of what they lost in the periods where prices fell and a little more. But in most investors’ experiences, that is all. Another perspective, and one we employ at Montgomery, is to focus first on risk. There are a number of ways to do this but the most elegant, if not the simplest, is to think first about the probability, or possibility, of permanent loss of capital.
‘Permanent loss of capital’ can itself be considered in two lights. The first is a capital loss and the second is a loss of purchasing power. Serious long-term investors, if the are focused on risk, think naturally about the loss of capital but less about the impact of inflation on their returns and, ultimately, their and their clients' lifestyles.
Alpha and beta
The stock market, of course, and the many academics whose fascination with it translates into research that seeks to further our understanding of money, markets and ourselves, spend an inordinate amount of time thinking about risk. And while there are emerging new ideas about risk, the biggest contribution from academia has hitherto been the measure of risk known as beta.