Volatility Is Not Risk
You should not confuse the two.
What is risk?
To the conservative investor, risk is a negative. To the opportunistic investor, risk is a factor to tolerate and accept.Whatever the perception of risk, it should not be confused with volatility. That confusion occurs much too frequently.
We can consider volatility a measurement of risk, but it is not risk itself.
Many investors and academics measure investment risk in terms of beta;In terms of an investment’s ups and downs in relation to a market sector or the entire market.If you want to measure volatility from a very wide angle, you can examine standard deviation for the S&P 500. The total return of this broad benchmark averaged 10.1% during 1926-2015, and there was a standard deviation of 20.1 from that average total return during those 90 market years.1
What does that mean? It means that if you add or subtract 20.1 from 10.1, you get the range of total return that could be expected from the S&P two-thirds of the time during the period from 1926-2015. That is quite a variance, showing that investors should be ready for anything when investing in equities. During 1926-2015, there was a 67% chance that the S&P could return anywhere from a 30.2% yearly gain to a 10.1% yearly loss. (Again, this includes dividends in the total return.)1
Example
Just recently, there were years in which the S&P’s total return fell outside of that wide range. In 2013, the index’s total return was +32.39%. In 2008, its total return was -37.00%.2 When statisticians measure the volatility of major indices like the S&P 500, Nasdaq Composite, or Dow Jones Industrial Average, they are measuring market risk. Trying to measure investment risk is another matter.
Perhaps investment risk is not measurable.
How can investors measure the probability of a loss when they invest? Even after they sell an investment, can they go back and calculate what their risk from the beginning? They only know if they made money or not. Profit or loss says nothing about risk exposure.
Most experienced investors do not fear volatility.
Instead, they fear loss. They think of “risk” as their potential for unrecoverable loss. In reality, most apparent “losses” may have recovery potential, given enough time. True unrecoverable losses occur in one of two ways. One, an investor sells the investment for less than what he or she paid for it. Two, some kind of irrevocable change happens, either to the investment itself or to the sector to which the investment belongs. For example, a company goes totally out of business and leaves investors with worthless securities. Or, an innovation transforms an industry so profoundly that it renders what was once a leading-edge company an afterthought.
Accepting risk means accepting the possibilities of equity investing.
The range of possibilities for investment performance and market performance is vast. History has shown that to be true, history being all we have to look at. It cannot tell us anything about the negative (or positive) disruptions that could come out of nowhere to upend our assumptions. A “black swan” (terrorism, a virus, an environmental crisis, a quick evaporation of investor confidence) is always a possibility. Next year, the performance of this or that sector or the small caps or blue chips could be spectacular. It could also be dismal. It could certainly fall in between those extremes. There is no way to calculate it or estimate it in advance. For the equities investor, the future is always a flashing question mark, regardless of what history tells or pundits predict.
Diversification helps investors cope with volatility & risk.
When you spread assets across various investment classesm you may reduce a portfolio’s concentration in a hot sector. However, this also lessens the possibility of overweighting the portfolio in a cold one.
Volatility is a statistical expression of market risk, constantly measured. You should not confuse volatility with risk itself.
PhysiciansThrive.com
Marketing Pro, Inc., prepared this material, and does not represent the views of the presenting party, nor their affiliates. We have derived this information from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If they need help, we advise the reader to engage the services of a competent professional. This information should not be confused as investment, tax or legal advice and may not be relied on to avoid any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any investment.
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Securities offered through Lion Street Financial, LLC. (LSF), Member FINRA & SIPC. Investment Advisory Services offered through Physician Investment Advisors, LLC. Physicians Thrive and Physician Investment Advisors do not affiliate with LSF.
Citations
1 – fc.standardandpoors.com/sites/client/generic/axa/axa4/Article.vm?topic=5991&siteContent=8088 [3/31/16]
2 – ycharts.com/indicators/sandp_500_total_return_annual [3/31/16]
