Strategic Investment Group

How Risk Management Adds Wealth

March 2006

Some investors, while embracing risk management, have largely focused on downside protection in their understanding of risk analysis. But risk control is not simply about avoiding the perils of aggressive investing; limiting risk can actually add to the accumulation of wealth in a portfolio. Moreover, the proper allocation of risk, using a risk budget, can greatly enhance returns within a given risk limit, which further increases the compound growth rate of wealth.

Investors tend to view the risk/return relationship as a trade-off in which the pursuit of higher long-term returns entails the shouldering of greater risk. This oversimplifies the role of risk within the portfolio. Lower risk — in the form of reduced volatility — can actually lead to greater median expected wealth in the long run. Even investors who are not concerned with absolute loss in the short-term should pay attention to volatility and its impact on long-term return.

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