One of the more difficult communications challenges for financial advisors is getting across the idea that a number means so little.  For example, is 4% a good return or a bad return?  If you take minimal risk and get 4%, then it is probably a good return.  If you take a great deal of risk and only get 4%, then it is probably a bad return.  A more meaningful number would be how much risk did you take, which is impossible to quantify.

I met an advisor who had a clever way to explaining this concept of risk-adjusted returns.  Suppose your son gets a new job.  On his first day, he realizes there are two logical routes he can take to drive home.  One route takes him through gently-rolling countryside of well-maintained roads with little traffic.  The other route takes him through an urban area known for gang wars and car-jackings, travelling on poorly-maintained roads and decrepit bridges.

That afternoon, he puts the roof down on his Mustang convertible and enjoys a leisurely drive through the countryside, arriving home in 27 minutes.  The next day, he puts the roof up on his Mustang convertible, keeps a pistol on the passenger seat, while making jack-rabbit starts through the slums but still arrives home in 27 minutes.

Which is the better route, and why can’t you quantify the difference in risk?