Risk is one of the biggest subjects in the investment world.
When the market is up, as it currently is, the perception of risk by most investors and speculators is low. The reality is that risk is high. A simple example of this is the current historical price earnings (P/E) ratio. The P/E ratio of the S&P 500 is currently 37. This means that investors are willing to pay, on average, 37 times the latest annual earnings of the S&P 500. So, a company with no growth would take 37 years for that company to earn an amount equal to the amount paid for the stock.
People don’t buy a stock expecting no growth. With a 37 P/E, they expect a significant level of year to year growth in company earnings. With higher expectations of growth, there is also a higher probability that any of a number of events could intercede to derail the expected growth.
When the market is down, the perception of risk by most investors and speculators is high. If P/E ratios are, on average, 10, it would take 10 years of earnings to equal the price paid for the stock assuming no growth. With smaller expectations of earnings, shown in the lower P/E ratio, the probability of reaching the expected growth levels is much higher.
The reality of risk is that investors and speculators perceive it at exactly the opposite side of the risk spectrum when in reality, they are 180 degrees the other way. This is a behavioral bias that successful investors must be cognizant of and use to adjust their thinking. Otherwise, the investor puts their portfolio at significant jeopardy.
Be smart, be well-read, be aware and be successful.
