The Difference Between Volatility And Risk

One of the most common mistakes that investors make is to confuse volatility with risk.

At best, it leads to unnecessary stress and worry, and at worst it can lead to heavy financial losses. It is therefore vital that investors understand the difference between the two.

At its simplest, volatility a way of describing the degree by which share values fluctuate. In volatile periods, shares prices swing sharply up and down while in less volatile periods their performance is more smooth and predictable.

Risk, on the other hand, is the chance of selling your investments at a loss, and the main factor that differentiates the two is your time horizon.

Interpreting volatility as “risk” is a misjudgement often caused by watching your stock portfolio too closely. In one sense, this is perfectly understandable; the stock market is a risky place to be in the short term, and watching the value of your life savings jump around from day to day can be gut-churning.

But investing in the stock market requires a longterm perspective; history shows that over periods of 10 years or more – it is a very profitable place to be. Crucially, it almost always outperforms alternative investments such as cash. For example, Brewin Dolphin’s analysis of a balanced portfolio benchmark over the past 20 years shows that the best time to invest was in 1998, just two years before the tech bubble burst in March 2000, and shares plunged in value. Even those that invested in 2000, literally just before the crash, would have seen their money more than double in the years since, although it would have been an extremely volatile ride along the way.

Remember, in that time we have endured the recession from 2001, the market bottoming out in 2003 and the financial crisis of 2008/9, when markets were swinging up and down by four or five per cent a day. Investors that took a shortterm view may well have made a loss, but those that kept calm and stood firm have reaped the rewards. The key is to remember that, over the long-term, with remarkable consistency, share values have always bounced back – sometimes in big, rapid leaps.

This demonstrates an equally important point: volatility can be a powerful force for good because these wild swings work both ways. For example, being out of the market for only the five best days during the past 20 years would have led to a 23% lower return. Missing the best 10 days would have reduced returns by a staggering 40%. So, while volatility may be stressful, experience shows it is better to stay invested in bumpy times. Timing the market with such precision is impossible.

Rest assured our experienced analysts are constantly monitoring the market and economic data, looking to make some judgement calls to move money from one asset to another to capitalise on market sentiment. This tactic has served us well and we have outperformed our benchmark index in 11 out of the last 13 years, through judicious use of our award-winning research and asset allocation strategies. But by far the most consistent message is that having a long enough time horizon and not reacting emotionally to market movements is key to success as an investor.