Volatility Versus Risk

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In the investment world, we often speak of the riskiness of an investment in terms of volatility: if an asset’s price changes rapidly and unpredictably, it tends to be spoken of as risky, and if the price tends to stay the same, it is usually regarded as “safe.”

In the short term, this is reasonable. If you have $100 today and you know that you will need $100 a week from today, the only sensible move is to put your money someplace where you know its value won’t change. Investing it in a volatile market means you might make a few extra percent your original money, at the unaffordable risk of coming up short when you actually need your money.

When we start to look at investing for the long term, though, we can start to see the difference between volatility and risk. Suppose you take your money and bury it in a hole in the ground for 30 years: this is about the least volatile “investment” you can possibly make. You can reasonably expect that the value of your buried money will stay nearly constant. Yet, because of the existence of inflation, it is almost a certainty that your money will lose a lot of purchasing power over the course of 30 years. Essentially you have a 100% chance of losing value over the long haul despite having virtually no day to day volatility.

On the other hand, if you took your money and invested it for 30 years, you can afford a lot of up and down movement during those 30 years—as long as the final value is higher than what you started with. If your investment has a daily gain 51% of the time and a corresponding daily loss 49% of the time, you can be fairly confident in your eventual profit—even though you’re watching the value go down several thousand times over the course of those three decades.

None of us know the future: there is no such thing as a guaranteed investment, and every investment incurs some form of risk. But it’s important to understand the difference between an asset’s volatility and its risk. For long-term investors, looking past day to day volatility can help you find bargains that are not as risky as you might think.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the loss of principal.