Risk "drag" in investing, poker

[Mr. Now]

Volatility matters. If you and I have the same average annual return but your results are more volatile, I end up with WAY more money on a compounded basis after 10 years.

This concept is essential to rational investing and rational poker.

Article:
https://www.bernstein.com/Public/story.aspx?cid=2602

[Scorpion Man]

Mr. Now, I appreciate your many contributions to this forum. However, I respectfully disagree with the substance of this post. Your commentary is simply wrong. A few guys got a Nobel prize for saying the opposite. The article you site does not even support your assertion.
"But doing so provides a hollow victory because, of course, assets with higher rates of return have historically come with higher volatility. As shown in the display below, over the period from 1980 to 2003, stocks entailed more risk than bonds or cash (stocks are farther to the right on the chart) but they also provided more return (they are higher up on the chart). So most investment plans should not be predicated on an objective of minimal volatility; doing so would unduly limit the opportunity for growth"

This is not a flame...but it's important that people realize your statement is patently untrue. There are situations in which it might be true...but that is totally different than the blanket statement you are making.

Perhaps your point is better termed that losing a huge % of your money at any point along the way is incredibly difficult to recover from. It does not follow, however, that folks with more volatile returns will end up with less money.

P.S. I am, in the scheme of things, not a risk loving investor or poker player. Nor am I endorsing taking big risks.

[ebranig]

Take two, 2-year investments, both with annual average return of 10%.

Investment A yields 10% each year, investment B yields 20% one year and 0% the other.

a: 1000 -> 1100 -> 1210
b: 1000 -> 1200 -> 1200

see?

[Mr. Now]

If you wish to pursue uncompensated volatility, by all means do so.

Go in peace.

[RedJoker]

[ QUOTE ]

Volatility matters. If you and I have the same average annual return but your results are more volatile, I end up with WAY more money on a compounded basis after 10 years.

This concept is essential to rational investing and rational poker.

[/ QUOTE ]

Completely agree. Scorpion Man, this was the point of the first section of the enclosed article. Your quote was from the next section.

[ QUOTE ]

Are you saying that its better to have less volatility in your bankroll?

[/ QUOTE ]

No; it's better to have less volatility if your return would be the same.

[ QUOTE ]

If you take NLHE for instance, a LAG style with hi volatility can produce far better average returns that a TAG nitty style over what would probably be considered the short term in investing, three or six months (which they call the long run in poker lol).

If I had to venture a quick guess I'd say a good LAG can make at least 40-60% more per hand/hour/month etc than a good TAG. Surely the added volatility is an acceptable cost for this gain.

[/ QUOTE ]

In this case the volatility is compensated; the LAG makes a higher return by accepting greater risk. In the article they are stressing the dangers of uncompensated volatility, avg. single stock had much greater risk than the SP-500 w/o receiving greater return.

[ QUOTE ]

Take two, 2-year investments, both with annual average return of 10%.

Investment A yields 10% each year, investment B yields 20% one year and 0% the other.

a: 1000 -> 1100 -> 1210
b: 1000 -> 1200 -> 1200

see?

[/ QUOTE ]

The investments have the same average annual return, 10%. They do not have the same compounded annual return, A = 10% and B = 9.54%.

Compounded annual return is the return which matters; you improve compounded annual return by reducing volatility (assuming annual average return is fixed).

[Scorpion Man]

[ QUOTE ]
Take two, 2-year investments, both with annual average return of 10%.

Investment A yields 10% each year, investment B yields 20% one year and 0% the other.

a: 1000 -> 1100 -> 1210
b: 1000 -> 1200 -> 1200

see?

[/ QUOTE ]

Ebranig...as I said in my post, it is not hard to come up with an example where this is true. That is totally different than saying its a "law" or a "theorem". The statements are just wildly wrong. They have some truth to them, kinda like urban legends, but they are wrong nevertheless.

[Scorpion Man]

[ QUOTE ]
[ QUOTE ]

Volatility matters. If you and I have the same average annual return but your results are more volatile, I end up with WAY more money on a compounded basis after 10 years.

This concept is essential to rational investing and rational poker.

[/ QUOTE ]

Completely agree. Scorpion Man, this was the point of the first section of the enclosed article. Your quote was from the next section.



[/ QUOTE ]

Guys, there is this little thing called CAPM. It won a Nobel Prize? It specifically says that certain kinds of volatility lead to higher returns for the precise reason that people should demand higher returns in order to hold them (because as a whole, investors are risk averse and not risk loving). This is not really up for debate. The main thing I am saying is that Mr. Now's generalization that he will have higher returns (by a lot, by the way) over time by having less volatility (as a rule) is patently wrong.


"CAPM decomposes a portfolio's risk into systematic and specific risk. Systematic risk is the risk of holding the market portfolio. As the market moves, each individual asset is more or less affected. To the extent that any asset participates in such general market moves, that asset entails systematic risk. Specific risk is the risk which is unique to an individual asset. It represents the component of an asset's return which is uncorrelated with general market moves.

According to CAPM, the marketplace compensates investors for taking systematic risk but not for taking specific risk. This is because specific risk can be diversified away. When an investor holds the market portfolio, each individual asset in that portfolio entails specific risk, but through diversification, the investor's net exposure is just the systematic risk of the market portfolio.

Systematic risk can be measured using beta. According to CAPM, the expected return of a stock equals the risk-free rate plus the portfolio's beta multiplied by the expected excess return of the market portfolio"

[edtost]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]

Volatility matters. If you and I have the same average annual return but your results are more volatile, I end up with WAY more money on a compounded basis after 10 years.

This concept is essential to rational investing and rational poker.

[/ QUOTE ]

Completely agree. Scorpion Man, this was the point of the first section of the enclosed article. Your quote was from the next section.



[/ QUOTE ]

Guys, there is this little thing called CAPM. It won a Nobel Prize? It specifically says that certain kinds of volatility lead to higher returns for the precise reason that people should demand higher returns in order to hold them (because as a whole, investors are risk averse and not risk loving). This is not really up for debate. The main thing I am saying is that Mr. Now's generalization that he will have higher returns (by a lot, by the way) over time by having less volatility (as a rule) is patently wrong.


"CAPM decomposes a portfolio's risk into systematic and specific risk. Systematic risk is the risk of holding the market portfolio. As the market moves, each individual asset is more or less affected. To the extent that any asset participates in such general market moves, that asset entails systematic risk. Specific risk is the risk which is unique to an individual asset. It represents the component of an asset's return which is uncorrelated with general market moves.

According to CAPM, the marketplace compensates investors for taking systematic risk but not for taking specific risk. This is because specific risk can be diversified away. When an investor holds the market portfolio, each individual asset in that portfolio entails specific risk, but through diversification, the investor's net exposure is just the systematic risk of the market portfolio.

Systematic risk can be measured using beta. According to CAPM, the expected return of a stock equals the risk-free rate plus the portfolio's beta multiplied by the expected excess return of the market portfolio"

[/ QUOTE ]

are you really trying to say that the CAPM isn't up for debate, as it applies to real financial markets (not as a theoretical construct)?

[RedJoker]

[ QUOTE ]

The main thing I am saying is that Mr. Now's generalization that he will have higher returns (by a lot, by the way) over time by having less volatility (as a rule) is patently wrong.

[/ QUOTE ]

This is Mr. Nows quote:
[ QUOTE ]

Volatility matters. If you and I have the same average annual return but your results are more volatile, I end up with WAY more money on a compounded basis after 10 years.

This concept is essential to rational investing and rational poker.

[/ QUOTE ]

Please note: If you and I have the same average annual return

Let's take the Lucent figure, 29%:

If I receive 29% return each year for 2 years I get:
(1.29)^2 = 1.6641 or 66.41%

If I receive 30% the first year and 28% the second year I get:
(1.28)x(1.3) = 1.664 or 66.4%

Note the first number is larger; this is not a mathematical trick. Any random set of returns (which have the same average annual return) will produce a lower compounded annual return as variance from the mean (29%) increases.

Over a two year period, getting 29% average annual return, 66.41% is the maximum compounded return possible. This has a standard deviation of 0 or no volatility.

The variance from the mean reflects volatility. Mr. Nows comment holds true both theoretically and mathematically.

Mr. Now did not claim that having less volatility (as a rule) will result in bigger returns.

Higher risk will generally result in greater returns BUT, in this example, the average annual return is fixed, we cannot increase it by accepting greater risk.