How can you best communicate what investment risk means to you?

Some critical aspects of finance are hugely subjective, which raises the question of how best to avoid ambiguity and the chance of misunderstanding when communicating with others about them



Andrew Evans
Fund Manager, Equity Value

The worlds of investment and finance in general are often criticised – and justifiably so – for being overly fond of jargon.

Arguably of even greater risk to investors, however, are words and phrases that, on the face of it, appear straightforward but can mean markedly different things to different people.

‘Value for money’ would be a good example – as would a word we have already used in this piece: ‘risk’.

These are tricky concepts for everybody involved in investment and finance – consumers, providers, advisers, the media, the regulators – because they are so subjective.

Nobody can definitively state: “This option represents good value for money for you.” Nobody can definitively state: “This option represents too much risk for you.”

Focusing in on risk as an example, here on The Value Perspective, we would argue the erosive nature of inflation makes it risky to hold too much cash (note the way we have given ourselves wiggle room by using another subjective phrase ‘too much’).

And yet, even at a time of historically low interest rates, millions more Brits still prefer to put billions more pounds into cash Isas than they do into the stocks and shares variety.

The military isn't immune either 

The dangers inherent in communicating the ideas of risk and uncertainty are by no means confined to investment, however.

Take the rather more life-or-death world of military intelligence – in his study Psychology of Intelligence Analysis, for example, Richard Heuer highlights an experiment where analysts were asked to put a numerical probability on a line of a report they had prepared earlier.

The line was the simple enough “The cease-fire is holding but could be broken within a week” yet, while one analyst said he had meant there was a 30% chance the cease-fire would be broken within a week, his colleague said she had meant there was an 80% chance of this happening. “Yet when working together on the report,” writes Heuer, “both analysts had believed they were in agreement about what could happen.”

Heuer also references a wider experiment where 23 NATO officers accustomed to reading intelligence reports were given a number of sentences where the only difference was the wording at the start, which ranged from “Almost certainly …” all the way down to “Chances are slight …”.

Again they were asked to attribute numerical probabilities to each sentence – and again there was a wide disparity of interpretation.

As Heuer notes, “an intelligence report may have no impact on the reader if it is couched in such ambiguous language the reader can easily interpret it as consistent with his or her own preconceptions”.

Incidentally, you can read a quirkier view of how different professions view probability – from weather forecaster and political journalist to ‘Mission Impossible Agent’ (“What would that even mean?”) at Maths with Bad Drawings.

The site’s creator has yet to come up with an illustration of how a value investor sees risk – presumably because it would be nowhere near as amusing as that of ‘Millennium Falcon captain’ on ‘probability of successfully navigating an asteroid field’ (“Never tell me the odds”) – so it seems appropriate to finish with a quick observation of how we communicate risk to each other, here on The Value Perspective.

Don't leave language up for interpretation

As we have written in articles such as Four investment edges, an integral part of our investment process is to balance our assessment of the associated risks of buying into a business with the potential rewards.

Naturally this means we have to find a suitable way to convey our perceptions of risk to other members of the team and, as we have seen, the subject matter involved means using language leaves things open to misinterpretation.

Instead, our answer is to use a numerical scale.

It is not a perfect solution, we admit – but then, in matters of subjectivity, nothing short of telepathy will be.

And, appropriately enough, we have found using numbers to describe risk does reduce the risk of misunderstandings.

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Andrew Evans
Fund Manager, Equity Value


The Value Perspective
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