Part One: What is risk?

Introduction

In this tutorial, we will explore the concept of risk in investing as presented by Howard Marks in his video on Oaktree Capital. Understanding risk is crucial for investors as it directly impacts investment decisions and outcomes. This guide will break down key points from the video, helping you grasp the relationship between risk and return, and how to assess investment success.

Step 1: Understand the Nature of Risk

• Risk is defined as the potential for loss or the uncertainty of an investment's return.
• Differentiate between systematic risk (market-wide risks) and unsystematic risk (specific to a company or industry).
• Recognize that all investments carry some degree of risk, and the goal is to manage it rather than avoid it.

Practical Advice:

• Always conduct thorough research on market conditions and individual assets.
• Diversify your portfolio to mitigate unsystematic risk.

Step 2: Assess the Risk-Return Relationship

• The risk-return tradeoff indicates that higher potential returns come with higher risk.
• Evaluate investments based on their expected return relative to the risk taken.
• Understand that past performance is not always indicative of future results.

Practical Advice:

• Use tools such as the Sharpe ratio to compare the risk-adjusted returns of different investments.
• Regularly review your investment strategy to ensure it aligns with your risk tolerance and financial goals.

Step 3: Recognize the Importance of Skill in Risk Management

• Marks emphasizes that successful investing involves skillfully assessing and managing risk.
• Investors should not only focus on the potential upside but also consider downside risks.
• Develop a strategy that includes risk management techniques.

Practical Advice:

• Create a risk management plan that outlines your risk tolerance and response strategies.
• Stay informed about market trends and adjust your investment approach as necessary.

Step 4: Consider Psychological Factors

• Recognize that behavioral finance plays a role in how investors perceive and react to risk.
• Avoid making impulsive decisions based on fear or greed.
• Maintain discipline and stick to your investment plan, especially in volatile markets.

Practical Advice:

• Practice mindfulness or reflective techniques to manage emotional decision-making.
• Engage with investment communities or forums to gain different perspectives and support.

Conclusion

Understanding risk is essential for any investor looking to achieve success. By recognizing the nature of risk, assessing the risk-return relationship, managing risks effectively, and considering psychological factors, you can enhance your investment strategy. As you move forward, continually educate yourself about risk management and adjust your approach based on your experiences and market conditions.