That's why the stock market pays better than the bond market on average. There's more risk. The stock market pays about 9% annually on average, and the bond market pays about 5% annually on average. What you're asking me to do is to ignore all the years that I lost money when calculating my "reward" (i.e. my expected value).
"Risk" is not the same as "loss," and "reward" is not the same as "win." The reward is the expected value; the average that you'll win or lose. You incorporate both the good results and the bad results, weighing them according to their likelihood. The risk is not a measure of your maximum loss, it's a measure of how much variance there is. Then you can compare the risk and the reward to see if it's a tradeoff you're willing to make.
Incorrect. The AVERAGE expected value (i.e. reward) has to be higher to justify more risk.Originally Posted by Tucker Case
That's why I said it comes down to how much risk you're willing to tolerate. Taking the gamble of getting laid off is clearly the superior choice from an EV standpoint, it just depends if you're willing to take on more risk for more reward. Stocks versus bonds.Originally Posted by Tucker Case
Ya but I'm not the national average.Originally Posted by Tucker Case
...and since I only lose that money 10% of the time, that's a good bet.Originally Posted by Tucker Case
"Reward" does not necessarily imply positive economic gain. Losing less money (or not losing any money) can be a reward too.Originally Posted by Tucker Case
Wrong. I am betting a certain amount of money (which I can estimate based on my salary, my potential unemployment benefits, and the estimated amount of time I'd be out of work), weighing the probabilities, and deciding whether the risk/reward trade off is worth it.Originally Posted by Tucker Case
It's only "gambling" in the same sense that any financial decision is gambling.
Then you should understand the concept of expected value. That was probably the first thing I learned about poker.Originally Posted by Tucker Case
The problem with the poker analogy is that the concept of risk doesn't exist in poker. You ALWAYS make the play that will earn you the most money over the long term (i.e. the play with the highest reward) regardless of the risk/variance in any individual hand. Good poker players never play scared. If you have a 2% chance of hitting your out and your pot odds are 1%, you pony up the cash even though you're going to lose it 98% of the time.
That isn't true in finance. We assume at least some degree of risk-aversion. Why? Because we aren't playing hundreds of thousands of hands where the bad beats and lucky breaks will even out over time; we're only playing a few hands over the course of our entire lives. In finance, the more risky the gambit, the higher my average reward needs to be. Conversely, the higher my average reward, the more risk I'm willing to tolerate.
The reward (expected value) is higher in the layoff scenario. The risk is also higher (since the variance is greater). Whether you're willing to tolerate more risk for more reward just depends on how risk-averse you are.Originally Posted by Tucker Case
I think you are confused as to what "risk" is. Risk is a measure of uncertainty, not a measure of loss. For example, it's much more risky for me to jump out of an airplane with a parachute than for me to jump out of an airplane WITHOUT a parachute. In the latter case, I know with nearly 100% certainty what will happen. There is virtually no risk.Originally Posted by Tucker Case