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Risk Budget Concept

The concept of a risk budget is a useful one. It relates to how much capital, within "reasonable" probability, are you prepared to put at risk, while seeking to earn a higher return than cash.

Reminder of the logic of portfolio theory + risk budget

Investors can somethings hope to only ever invest in places where they will definitely get a reasonable return. However, in reality:

  • every time we seek to invest (i.e. every time we risk our capital) we are hopefully putting our capital in a place that has a reasonable probability of getting a better return on cash over a certain time-frame.

  • No one investment is an absolutely certainty over any time-frame. That is one of the very strong messages from investment history.

  • And diversifying between a range of investments (each of which has a good probability of a better return than cash over a certain time-frame), is one technique that we use to try to reduce investment risk.


One of the other tools in our investment tool-kit is the risk budget concept.

  • Risk tolerance = the preparedness to risk losing capital while pursuing a higher return than cash.

  • Risk-averse investors (those with a low tolerance of a negative return) have only a small “risk budget” to “spend” when investing.

  • Aggressive investors (those who have a high tolerance of a negative return) had a large “risk budget” to spend.

  • We can choose to spend our risk budget on a larger number (amount) of investments with lower risk OR on a smaller number (amount) of investments with higher risk AND still have the same overall portfolio risk.

  • If our portfolio is 100% cash, this means that either:

    • we have no tolerance for risk OR

    • we can currently find no investments with an acceptable level of risk OR

    • we may be applying Jeremy Grantham’s ( ) investment philosophy of, in periods of extremely high investment risk, “waiting for the good cards”.

      • In this context, it is useful to also remind you of Marc Faber’s comment on 1/9/2020 that “Great Investors have Discipline and Patience”.

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