Our investing experience over the last two years vividly demonstrates the problem with confusing volatility and risk.
After years of relative stability, a certain security plunged by more than 80% in a few months. The standard model of risk would have you believe that the security was relatively safer at the high price level. And the more the price declined, the riskier it became—according to the standard methods.
Value investors seek the bargains. To them, the lower the price, the better the deal. This is exactly the opposite of the standard model of risk.
The rest of the story is that the security turned on a dime at the low point, and rose back to its original level in the following months. At the very point the standard model of risk viewed this investment in the worst light, it was preparing to embark on a rise of more than 400%.
There is a good reason why people (including professionals) confuse volatility with risk. In the short term, volatility IS risk. If you have wealth to pay the bills due within a few days, you cannot afford to have the value bouncing around from day to day. If it goes the wrong direction, you might not have enough money to pay the bills.
Therefore, whether volatility is risk depends on the time horizon. In the short term, volatility is risk. In the long term, perhaps volatility is opportunity, not risk. We work hard to understand your time horizon so we can get this right for you.
Clients, if you would like to talk about this in more detail, or have other things on your agenda, please email us or call.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.
This is a hypothetical example and is not representative of any specific investment. Your results may vary.