People don’t perceive that they are going to be the one in a crash,” laments Russ Rader, media director at the IIHS (Insurance Institute for Highway Safety). They believe that they are in control when they’re behind the wheel. They don’t sense how high the risk actually is.” The IIHS, a Virginia-based, national nonprofit that has helped significantly increase seat belt usage in the last twenty years, has a simple objective: lessen the risk taken in everyday driving behavior. The risk-measurement approach it employs has the potential to revolutionize how the investment community evaluates manager performance.

Ever since the Great Depression, the Federal Reserve has been in charge of creating money supply. When the economy is threatened with recession, the Fed shovels money into the system, where consumers spend it to buy everything from groceries to automobiles, creating jobs. When the economy overheats, the Fed shrinks the money supply to retard inflation.

While this may surprise you, the wisest thing you can say to a client is: “I’d like to assure you that you may lose money in about three of the next 10 years, regardless of where you invest. My job is making sure those years don’t ruin your plans.”

As advisors, we tend to adroitly sidestep the topic of losses. Clients don’t hire us to lose money; yet, we know that at some point, it will happen. We have cursory conversations about risk tolerance and the ubiquitous cautions about how “past performance is no guarantee of future success,” but few advisors prepare clients for losses forcefully and well in advance.

DryShips is a public company. But the way George Economou runs the place, you’d hardly know it.

Sitting in the library bar of Manhattan’s Regency Hotel, Greek shipping billionaire George Economou throws back a salted nut before confronting the shareholder complaints that have been swirling around him. “Listen, guy,” he says as if conducting a fractious conference call. “If you don’t like it, you don’t have to be here. Sell the stock.”

The subprime crisis is yet another reminder that the markets are inherently volatile. There are no investment products or strategies that can capture all the upside of rising markets and avoid losses on the downside. Every equity strategy entails risk. The key to consistent long-term investment performance is to secure most of the upside in good markets and avoid significant losses when the markets are down.

There are so many sources of investment data that you can easily find support for any hypothesis. Whether you think a particular stock will rise or fall, there are ample data to back up your judgment. The key to great investing, therefore, is not gathering data, but understanding what it means in relation to the stock market as a whole. And that understanding can only be achieved through critical thinking.

Advisors tell me the first question clients invariably ask about their retirement portfolio is, “What will my investment returns be?”

That’s a legitimate concern, but it’s the wrong question. The first questions should be:

“How much risk does my portfolio have?”

“How many years will my retirement be set back if I lose 25 percent or 50 percent of my investment principal?”

Risk should always be evaluated before potential return. It is not a new idea.

Investors commonly confuse a good business with a good investment. Many good businesses have high expectations embedded in their stock prices. As an investor, you face the task of recognizing whether current expectations are overly optimistic or overly pessimistic. Changes in expectations – not earnings growth – move stock prices.

My son, who is a CPA, called me last week to ask for my advice. After picking the phone up off the floor where I had dropped it, I asked him what was up. It seems that one of his New Year’s resolutions was to do a better job with his equity portfolio. He turned 40 last year, a milestone that apparently prompted a reassessment of his retirement assumptions. Given the inconsistent performance of his portfolio, his dream of selling his practice and sailing off into the sunset at age 50 is in serious jeopardy.

Most medical professionals I talk to consider investment performance — annual returns — the most important element of their retirement portfolio. That’s an important consideration, of course, but of even greater consequence is lowering portfolio risk. Those who expect to be financially secure at retirement typically harbor some misconceptions…