Risk is not only from the market

Risk is never a negative term that people should hate and avoid. In the financial market, risk and return are two terms that are tightly tied with each other that investors seek for higher returns in order to compensate higher risk. Here risk is still not a neutral term as the term “compensation” is used. I think that risk is uncertainty with rough knowledge of possibilities of possible future outcomes and those future outcomes which are unknown are not counted as risk, instead they are black swan events that are usually ignored as it is impossible to predict and make reasonable expectations.

Some risk is zero-sum that there are only two kinds outcomes and one of the two is zero (losing everything). Under such risk environment, participants usually have more risk loving preferences in order to allow themselves to be in such situation. Such situation is usually related to gambling or similar activities. However, it is not necessary to consider such risk is “bad”, as under good management of risk, it could lead to positive expected outcomes and the losses could be lower than people’s bearable budgets.

When we are calculating expectation outcomes for future events, it usually involves these several elements: possible states, probabilities, discounted rates. However, if we believe any investment other sources of incomes should be spent on consumption for now and future. Therefore, once we design our investment and consumption plans, we have to ensure the lowest expected outcomes should be higher than the highest possible overall consumption; otherwise, we put ourselves in conditions where we are possible to bankrupt.

To us, discounted rate and future consumptions are also sources of risk, as they are uncertain and not entirely controlled by ourselves. As we are more able to control our consumption than the discounted rate as discounted rates are determined by exogenous factors, the discount rates for the future could be seen as a normal distribution that its future outcome could be any within a range.