It is a given that when someone invests money there is a potential for loss. How much loss and when is an absolute unknown. The only protection against such a potential loss is a contractual guarantee, and even then it may not be. (See the recent debt crisis in Washington)

What is possible, however, is an understanding of the tools used by money managers and financial advisors to quantify past losses. Once those numbers are available in a data set, it becomes a matter of comparison to make a reasonable guess about the probability of future losses. But it is still a guess.

The name we use for this tool is Semi Standard Deviation or Semideviation. Here is how Investopedia explains the term:

“In portfolio theory, semideviation evaluates the fluctuations in returns below the mean. It provides an effective measure of downside risk for a portfolio. It’s similar to standard deviation, but it only looks at periods where the portfolio’s return was less than the target or average level. This allows investors to see how much loss can be expected from a portfolio, instead of only looking at its expected fluctuations.”

There is a similar word, Semivariance, that Investopedia defines this way:

“Semivariance is similar to variance; however, it only considers observations below the mean. A useful tool in portfolio or asset analysis, semivariance provides a measure for downside risk. While standard deviation and variance provide measures of volatility, semivariance only looks at the negative fluctuations of an asset. By neutralizing all values above the mean, or an investor’s target return, semivariance estimates the average loss that a portfolio could incur.”

“For risk averse investors, solving for optimal portfolio allocations by minimizing semivariance would limit the likelihood of a large loss.”

Financial advisors who can articulate a number for a given portfolio mix are in a better position to help their clients maximize their return by minimizing the risk of loss.

Yesterday, in conversation with a client, she asked me about the level of risk associated with a proposed change I was recommending. Mindful that once again I have no idea what I am having for lunch tomorrow and therefore have no idea what the markets will do going forward, it’s always good to focus some attention on reducing the likelihood of loss. I was able to give her a number that compared favorably with a known investment choice.

I now have the tools to do this analysis, and that’s a good thing. At least that’s my plan, and I’m sticking with it.