Among professional investment managers, risk is defined, primarily, as a return that is either higher or lower than expected. A better-than-expected return is a risk? Absolutely. It usually means the investment is riskier than anticipated. Ch-ch-ch-ch-changesThat’s because the higher the return, the greater the risk in terms of how often and how much asset prices move up or down, both in relation to the market (relative risk) or to a so-called risk-free investment such as cash or cash-equivalents (absolute risk). This is also called volatility.154It measures the extent to which asset prices swing above and below their longer-term trend. It matters a lot to, for example, fund managers because a surge in the number of fund investors wanting to redeem might coincide, as often happens, with a major market setback, leaving the fund short of the necessary cash. There are many investment types and instruments, each with its particular level of risk or volatility. A common illustration of this is the ‘risk pyramid’, with the riskiest investments at the top and the safest forming a wide base.156Often, private investors focus only on the two lowest levels, thereby condemning themselves to low returns. At present, these don’t even compensate for the inflation that is continuously eating at the supposedly safe capital of the over-cautious. On the other hand, no prudent investor should commit all of their money to the pyramid’s top levels. The safety danceThe time-honoured methods for managing investment risk are, first, diversification, and, second, risk-weighting. The first entails investing across different assets (cash, bonds, equities, and real estate, for example), and/ or different markets (the USA, Japan, Germany, the UK, etc), and/ or different sectors (technology, retail, finance, and so on). The purpose is to ensure that, even when some assets may experience price weakness, others may not and, overall, your investment portfolio will be less volatile and, therefore, safer. In short, diversification means not carrying all of your eggs in one basket. Risk-weighting requires holding less of the riskier investments, with the majority of your holdings devoted to cash, bonds, and top-quality equities (‘blue chips’). For example, you might allocate 90 percent of your portfolio to blue chips, government bonds, and cash, but only 10 percent to property and crypto-assets.Living in the pastHowever, the world of risk is much broader than simply the volatility of asset prices. Besides, volatility is measured by looking at its past trend and assuming that will continue. When you think about it, that seems misguided. Risk is all about the unknown future, so how can its known history be a reliable indicator?The past 20-25 years has thrown up many examples of such broader risks, some almost completely unexpected. There have been the usual - and more predictable - market events, notably, the ‘dot-com’ bust of 2000, but major risk surprises came with the Brexit referendum and US election results of 2016. More recently, in 2020, we had the once-in-a-century worldwide coronavirus pandemic. Overarching all of these has been the existential risk of climate change.It all seems as if the infamous Murphy’s Law prevails: what can go wrong, will go wrong. That being so, what’s the point of taking any risk at all? Those risk-averse investors who put all of their money in bank deposits and government bonds can, surely, sleep better and have fewer worries than those of us holding equities and watching the prices gyrate every day?Crash and burnThe answer lies in the earlier point that the higher the return is, the greater the risk. In other words, you have to embrace risk - within reason - in order to achieve a reasonable rate of return. This is best achieved with an investment portfolio that is both diversified and risk-weighted, as described above. That prudent low-volatility (or low-risk) strategy can reduce short-term losses in a market downturn, while its long-term performance could, at least, match that from the market and is likely to outpace cash returns by a wide margin. The graph, below, compares what happened to a notional pair of lower-risk and higher-risk investment portfolios in the 2000-03 dot-com crash and the Great Financial Crisis (GFC, 2007-09). On both occasions, the high-volatility portfolio suffered sharp falls while its low-volatility counterpart saw much smaller setbacks.155Not only that, but the low-volatility portfolio delivered much better long-term returns. Its lead may have been only 0.9% a year but, had it been worth £1,000 in June 1973, it would have been valued 45 years later, in June 2018, at £139,601. That compares with just £96,971 for the high-risk strategy, a difference of no less than 44%.This result seems to overturn the risk-reward trade-off, where taking less risk also means accepting a lower return. How can that happen?Pledging my timeTime is the answer. The more of it that you have, the better chance your investments will perform well. Market crashes are temporary. They tend to happen every 10-12 years but are usually over in three years or less. Over the 45 years measured in the chart, there were three such setbacks, being the two already mentioned plus another in 1972-74. That was a total of about nine years of falling share prices, far less than the balance of some 36 years during which share prices were mostly rising. Given time, therefore, a lower-risk strategy not only reduces the damage from market downturns, but rewards you with a head start when prices resume their long-term climb. The comparison reveals another truth about risk. Many undertake investment in shares and other assets mainly in order to make money. That approach puts the cart before the horse, because a prudent investment strategy must be based, first, on a thorough assessment of the risks. Only when those have been measured can you make a reasonable assessment of the likely return. Or, as someone tweeted not so long ago: “It’s not about making a killing; it’s about not getting killed”.