For investors focused on earning returns through capital gains, risk is the probability that a trade that they make will end up losing money. That they’ll buy at one price and have to sell at a lower price thereby suffering a loss of the number of shares traded multiplied by the change in value per share.
The fact that their loss is predicated on the number of shares they own and the change in share price from when they bought may seem obvious and hardly worth mentioning but it’s a key factor when comparing risk to volatility which is a concept many use as a synonym for risk.
Volatility is a measure of how much short term movement there is in the price of shares of stock. Volatility is a short term concept and only generates risk when you’re making short term trades. Over the long term, a more volatile stock might have a more interesting ride but as long as the fundamentals of the company it represents are sound it will still show less volatile long term growth despite its short term price fluctuations.
So, for long term growth investors, volatility can mean a lot of things but if the right stock was chosen at the beginning the long term performance that they’re after will come no matter what the short or medium term stock chart looks like. They’ve chosen to invest a particular sum of money in shares of that stock and the long term price change of the stock will determine their profit or loss.
For dividend investors, any price appreciation in the share price of the stock is a bonus because it’s the dividend payments they’re after. Whether they’re using those dividends for current income, reinvestment, or to fund other investments their primary concern is how much dividend per share are being paid and how likely those dividends are to at least remain constant and ideally to grow.
Risk is therefore measured by the potential that a company will cut its dividend or slow its dividend growth. Shares of stock are bought for access to dividend payments and their value are predicated on whether or not they continue to deliver a steady stream of income throughout the life of the position not directly on the long term growth of the company.
Therefore, the primary risk for the growth investor is concentrated in a single decision – that they’ll choose the wrong stock and invest in shares that will decline in value over time. For the dividend investor, the primary risk comes from choosing a stock that won’t maintain a consistent and growing dividend stream over time.
The growth investor is starting with the premise that “this stock will go up” while the dividend investor is starting with the premise that “this stock’s dividends will stay up”. There a risk to both that their premise turns out to be wrong but, for the growth investor, it’s starting at zero and hoping for a positive outcome. For the dividend investor, it’s starting at a known level of income from dividends and hoping for continued or growing income from that point.
Thus, the risk in growth investing is choosing wrong and suffering losses while the risk in dividend investing is choosing wrong and not seeing the income that a dividend paying stock is already generating stay stable or increase. One starts with an unknown and the other starts with a known and the difference in risk is the difference between a company’s ability to manufacture profit vs. another companies ability to sustain profit.
Dividend investors simply choose the risk that a relatively known situation will change for the worse vs. hoping a relatively unknown situation will change for the better.
