Noise and Ruin

You can’t simplify risk into a simple number to fully capture the “cost” of returns. There are various measures for risk, that ask interesting questions. All of them have problems. Volatility is the most commonly used, as a measure of noise. How different the average outcome is, from the average outcome. If volatility is zero, there is no movement from the average. If sometimes it is higher, and sometimes it is lower, you are measuring the absolute difference from the average (whether below or above is ignored). If results are “normal”, you can get an idea of what the chance of an outcome being in a given range is. Another measure of risk is the probability of ruin. What is the chance that you are not going to be able to play the game anymore? The most important thing in most games is staying alive. Value is created over the long term and compounds. Survival is essential. You always need to know that you are going to be at least 5% okay, so that you can rebuild. Always have the capacity to regenerate, even in a huge disaster. Hold something back. Something that allows you to have a deep sense of security. Volatility, based on the past, can be zero right up till a point of ruin. There is no such thing as risk-free. 

Volatility is easy to measure, Ruin less so