Re-Thinking Risk
A while back I wrote about risk in the context of volatility and how that shapes decision making. It was really about getting comfortable with the idea that volatility isnât something to avoid because itâs often the price you pay for better long term outcomes.
Early on in my investing life, I really disliked volatility. A few big drawdowns will do that. Over time though, I started to reframe what risk actually is. Factor investing helped as it forced me to accept that volatility isnât a flaw in the process, itâs part of it.
That shift made me realize how often I/we define risk too narrowly.
Reading through posts, it seems like many investors tend to think of risk as price movementâŚred days, drawdowns, that uneasy feeling when things arenât going your way. But the bigger risks are usually quieter: inflation eating away at purchasing power, taxes compounding in the background, or just being too conservative for too long.
A smooth 2â3% return can feel safe, but after inflation and tax, it can quietly lock in a loss in real terms. Meanwhile, a more volatile portfolio that compounds at a higher rate can feel uncomfortable in the moment, but actually be much safer over time. Of course, that evolves over time as life changes, whether itâs retirement, a career shift, or something else, but the role of risk never really leaves the conversation.
So instead of asking how much volatility can I tolerate? I still think the better question is:
what return do I actually need to maintain or improve my standard of living?
But in todayâs market, I think thereâs another layer to add: risk-adjusted returns, and where youâre actually being compensated for the risks youâre taking.
For a long stretch, that was relatively straightforward. You could take duration risk or broad equity risk and expect to be rewarded. Today, it feels a bit more nuanced.
Some traditionally safe areas still carry hidden risks (like inflation or rate sensitivity). Some growth areas still look expensive relative to the uncertainty around them. And then there are parts of the market where the trade-off between risk and return looksâŚquietly more attractive.
This is where I think industrials are worth a closer look.
Not because theyâre risk-free, but because of how they sit in the current environment. Theyâre tied to real-world investment: infrastructure, capex, reshoring, defense, energy transition. A lot of that demand is being supported by longer-term spending cycles and fiscal policy, not just the consumer.
At the same time, some industrials are trading at higher multiples than people might expect. But in many cases, that may be the market pricing in a multi-year capex cycle before it fully shows up in earnings. The P/E can look stretched today, but the expectation is that earnings grow into it over time.
So the question becomes less about whether something looks cheap or expensive on the surface, and more about: are you being paid appropriately for the risk youâre taking, given what the next few years could look like?
Thatâs really the core of it.
Because avoiding volatility still has a cost. But so does taking risk in areas where expectations are already high and the margin for error is thin.
Curious how others are thinking about this:
* Where do you see the best risk-adjusted returns right now?
* Where do you think risk is underpriced or overpriced?
* And how are you factoring industrials into that view?
