What Most Investors Get Wrong About Risk (And How to Get It Right)
Uncertainty is the only certainty.
When most people think about risk in investing, they imagine sharp market drops, volatile stock charts, or complex financial ratios. But risk is far more than short-term price swings or technical metrics. It’s one of the most important—and misunderstood—concepts in finance. And getting it wrong can lead to poor decisions, emotional reactions, and lasting damage to your portfolio.
Understanding risk the right way changes everything. It shifts how you choose investments, how you size your positions, how you respond to uncertainty, and—most importantly—how you protect yourself when things don’t go as planned. This piece explores what risk really is, how to measure it thoughtfully, and how to manage it wisely—so you can make better decisions and build a strategy that endures.
What Is Risk?
Risk in investing is often misunderstood. Many equate it with volatility—rapid price swings or statistical measures like standard deviation. But that view is not real risk. True risk is not about how much an asset price moves, but about the possibility of losing money permanently, failing to meet your financial goals, or being forced into bad decisions under pressure. It’s as much about mindset and behavior as it is about numbers.
Take this example: if a stock rises from RM4 to RM8, is that riskier than one falling from RM4 to RM3? A stock that steadily climbs over time may seem safe, but if bought at an inflated price, it can expose you to significant downside. Meanwhile, a sharp drop might present lower risk if the price becomes attractive relative to fundamentals. This shows that volatility doesn’t equal risk—context, valuation, and timing matter.
Measuring risk is less about formulas and more about understanding possible outcomes. It involves probabilistic thinking: weighing different scenarios and judging whether the odds are in your favor—not with certainty, but with reasoned judgment. Since the future is inherently uncertain, and some risks cannot be precisely quantified, resilience becomes more important than precision.
As Howard Marks puts it, “Risk means more things can happen than will happen.”
Ultimately, risk management is about focusing on the downside—being prepared for what could go wrong. That’s why wise investors don’t obsess over predicting the future perfectly—they prepare for it. The real danger isn’t short-term price swings, but the risk of permanent capital loss or being forced to exit at the worst possible time. Managing risk means building a strategy that can endure, even when the unexpected happens.
As Morgan Housel says, “Risk is what’s left over after you think you’ve thought of everything.”
How do You Manage Risk?
Managing Risk from a Valuation Perspective
From a valuation standpoint, managing risk is not about adjusting the numbers to reflect uncertainty—it’s about ensuring you truly understand the business and can reasonably forecast its future. Since valuation depends on estimating future free cash flows and discounting them to the present using an appropriate rate, the real risk lies not in volatility, but in the uncertainty and sustainability of those future free cash flows.
Warren Buffett’s approach highlights a key principle: don’t rely on higher discount rates to compensate for unknowns. Instead of saying, “I don’t know what will happen, so I’ll use a 9% discount rate instead of 7%,” Buffett insists that if you lack conviction in a company’s future, you simply shouldn’t invest. He applies the same discount rate—typically anchored to long-term U.S. government bonds—to all businesses that meet his threshold of predictability.
Therefore, risk management in valuation begins with staying inside your circle of competence. Only value businesses whose economics you understand and whose long-term prospects are reasonably predictable. This reduces the likelihood of error in both your free cash flow assumptions and your discount rate.
Buffett also demonstrates that volatility is not the same as risk. If the business is sound and the future predictable, short-term market swings may offer opportunities rather than threats. In this view, the greatest risk isn’t price fluctuation—it’s misjudging the durability of cash flows or overestimating your ability to forecast them.
Ultimately, the best way to manage valuation risk is not to manipulate the discount rate, but to focus on business quality, long-term visibility, and staying within areas where you have deep understanding. This approach gives you a higher probability of making the right investment decisions over the long term.
Managing Risk from Business and manager Perspective
Hillhouse Capital, founded by Zhang Lei, believes that the most crucial aspect of risk management is selecting the right people
Zhang famously said, “A first-rate individual will thrive in a third-rate business, whereas a third-rate individual will struggle in a first-rate business.”
One example is Hillhouse’s early investment in JD.com, a company in the highly competitive and low-margin e-commerce space. Despite the tough industry, Zhang recognized the exceptional leadership of founder Richard Liu, whose vision and execution transformed JD into one of China’s leading e-commerce platforms. This reflects Zhang’s conviction that great people can shape organizations, drive culture, and create lasting value—even in challenging environments—and turn difficult businesses into success stories.
However, others like Warren Buffett argue that the business model and industry should come first, as they are more predictable over time. Buffett learned this the hard way. He struggled for years with Berkshire Hathaway, which originally operated as a textile manufacturer. Despite his brilliance as a capital allocator, the declining industry made it extremely difficult to generate strong returns. That experience taught him a key lesson: no amount of skill can overcome a fundamentally poor business model. Since then, Buffett has focused on simple, durable businesses with strong economics—like Coca-Cola or See’s Candies—believing that a great business can succeed even with average management, whereas a bad business will eventually wear down even the best leaders.
Both perspectives hold value—they simply reflect different past experiences. Zhang Lei prioritizes extraordinary people, while Buffett focuses on predictable, high-quality businesses. It's ideal to have both, but if you can only choose one, the business model and industry should come first, as they are generally easier for the average investor to identify and more predictable over the long term than a manager’s capabilities.
Warren Buffett once said, “If you’re trying to jump over a seven-foot bar, and you have a five-foot bar you can step over, why not take the easy one?”
Managing Risk Through Price and Time
Managing investment risk isn’t just about avoiding bad assets—it’s about paying the right price and allowing sufficient time for quality to reveal itself.
As Howard Marks emphasizes, risk is not inherent in the asset alone—it depends on the price you pay. Buying even a great business at an inflated price introduces risk, as future returns diminish and expectations become harder to meet. Conversely, when prices are low, risk can actually decrease because much of the negative news is already reflected in the price, and the potential upside improves.
His core message is: “Good investing is not about buying good things, but about buying things well.”
Time also plays a critical role in reducing risk, as Warren Buffett points out. He notes that it’s only risky if you’re forced to sell tomorrow. But when you buy a high-quality business and give it time to grow, the risk of permanent loss shrinks dramatically. His investment in Coca-Cola is a prime example—while short-term volatility exists, the long-term compounding of a strong business makes the investment increasingly secure over time. With time, quality becomes your ally, and the margin of safety widens.
This aligns with Benjamin Graham’s concept of a margin of safety, which provides a built-in buffer against two unavoidable realities: human error and random, unforeseen events. Since valuation involves subjective judgment—and investors are prone to bias and irrational behavior—having a margin of safety buy a dollar for 50 cents is essential. It ensures that even if you're wrong on timing or assumptions, your downside is limited. And if things turn out well, it gives you the opportunity for even better returns.
Managing Risk Through Portfolio Construction and Position Sizing
Managing risk in a portfolio begins with understanding that success doesn't depend on always being right, but on how well you manage outcomes.
As George Soros famously said, “It’s not whether you’re right or wrong that’s important, but how much you make when you’re right and how much you lose when you’re wrong.”
This highlights the importance of asymmetry in investing—letting your winners grow and cutting your losses early. Soros prioritized flexibility over rigid conviction, often adjusting his positions quickly when the facts changed. This mindset encourages investors to focus on position sizing and capital preservation, rather than ego or the need to be consistently right.
Charlie Munger and Warren Buffett advocate for a concentrated portfolio strategy when you have deep understanding and high conviction. Munger has criticized excessive diversification as “diworsification,” believing that spreading capital across too many ideas can dilute returns. Buffett demonstrated this in his early partnership years by allocating up to 60% of his capital into a single stock. Both believe that real risk lies in ignorance, not in volatility. If you truly understand a business and its long-term prospects, concentration can actually reduce risk—because it reflects informed, intentional investing. Around 15–20 stocks: You achieve most of the diversification benefit.
Many conventional portfolio managers measure risk using beta—volatility relative to the market—but this approach is strongly rejected by Munger. Nick Sleep offers a more insightful framework for managing portfolio risk: the price-to-value ratio. This method compares a stock’s market price to its intrinsic value, guiding investors to focus on buying undervalued businesses with strong upside and limited downside. A lower price-to-value ratio indicates a wider margin of safety and reduced investment risk. Unlike beta, this approach supports long-term value investing—emphasizing the importance of buying great businesses at good prices and giving them time to compound.
Managing Risk from a Personal Perspective
Managing investment risk is a deeply personal process—shaped not just by external market forces, but by your own financial situation, mindset, and emotional resilience. Each investor operates under different circumstances: some have ample disposable income and stable cash reserves, while others face tighter budgets, debt obligations, or lower risk tolerance. Because of this, there’s no one-size-fits-all approach to personal risk management. However, one principle holds true across the board: never invest beyond your means, and always maintain a financial buffer. This cushion not only protects you from life’s inevitable surprises but also ensures you can stay invested long enough for compounding to work in your favor.
Peter Lynch and Morgan Housel both highlight the psychological dimension of personal investment risk. Lynch reminds us that the real danger isn’t short-term volatility, but the emotional reactions it provokes—panic selling, chasing trends, or abandoning good businesses too early. His advice is to ignore the market noise, stay focused on company fundamentals, and give your portfolio the time it needs to grow. Similarly, Housel emphasizes that the ability to endure discomfort is essential for long-term success. Market swings are inevitable, but what separates successful investors is their ability to remain calm and consistent through periods of uncertainty. Together, their insights underscore that emotional discipline and resilience—both mental and financial—are among the most underappreciated tools for managing personal risk.
Finally, Li Lu underscores the importance of independent thinking. Managing risk means making decisions based on your own research, principles, and understanding—not simply following the crowd. You need to dare to be different. In the long run, true safety comes not from consensus, but from having sound reasoning, knowing your portfolio, trusting your judgment, and aligning your strategy with your own goals and limits. In essence, personal risk management isn’t about predicting the future—it’s about knowing yourself, preparing for uncertainty, and staying grounded through it all.
My Final Thought
Through my investing journey, I’ve come to understand that risk isn’t something to fear—it’s something to approach with respect, clarity, and thoughtful management. It’s not defined by volatility or market noise, but by the potential for permanent capital loss, emotional misjudgment, and the failure to achieve long-term goals. Whether you're evaluating a company’s fundamentals, managing your temperament, or building a portfolio, effective risk management begins with knowing yourself, understanding what you’re investing in, and having the discipline and patience to let time work in your favor.
While risk can’t be eliminated—and shouldn’t be ignored—it can be understood, prepared for, and handled wisely. The most successful investors aren’t those who predict the future perfectly, but those who are resilient, well-prepared, and clear-headed in the face of uncertainty. If there’s one principle I carry forward, it’s this: invest not with the illusion of control, but with a deep respect for uncertainty—and a commitment to stay grounded, rational, and long-term oriented no matter the noise.
No matter how well you plan, stay humble about your limitations—because uncertainty is the only certainty.
Disclaimer: The information provided in this article is based on my personal analysis and should not be considered as financial or investment advice. Readers are advised to conduct their own research and seek professional guidance before making any investment decisions. The accuracy and reliability of the information cannot be guaranteed, and I assume no responsibility for any losses or damages incurred. Investing in stocks involves risks, and past performance is not indicative of future results.