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Blog #36- What is The Difference Between Volatility And Risk in Investing??

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Blog #36- What is The Difference Between Volatility And Risk in Investing??

12th June 2017

Paddy Delaney

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Last week we explored what will happen when the next crash comes……and importantly how we will react. It is the volatility of things which causes us to react, not the risk!

Volatility is not risk, risk is not volatility. I’m not trying to be profound (it’s not one of my strengths!). In today’s world the two are thrown together, interchanged in conversations, media and advertising, yet they are 2 completely different things. It’s sort of like interchanging chalk and cheese in conversation:

Hey, did any of you students take the cheese I was using to write on this black-board? (showing my age there!)
Hey, would you like chalk on your ham & turkey sandwich?

Makes no sense, just as it doesn’t to mix risk and volatility, yet we all do it, and I am as guilty as the next fella/gal!

Now this may help some of you, and it may not help, yet it is a critical aspect of retirement planning, pensions, investing and savings of any sort here in Ireland, it is vital to understand the difference between the 2, particularly if you want to make informed money decisions…speaking of which please do pop over here to find out why we exist, what our purpose is and why we are Ireland’s first Financial Planning & Money Podcast. Also, if you have any questions or comments we’d love to hear from you, just drop a message to us here.

A Simple (yet somewhat odd!) Analogy:

Rollercoasters are scary! They are meticulously designed to scare the living daylights out of you! Yet they always deliver the goods, you feel exhilarated, possibly a little sick, but you got what you came for! The risk you feel when you get on a rollercoaster is that you may die, right? That is the worst that could happen, death is the risk you take! Statistically there is a 1 in 200 million chance of dying while on a roller-coaster, 200 million! Rollercoasters are scary but the risk associated with being on one is minuscule. Vending machines falling over kill about 4 times more people than roller-coasters per year (12 per year from vending machines, in U.S!).

Yet the amount of ups and downs we experience while on a roller-coaster is really high, that is what makes it so exhilarating (not for me, I hate the bloody things!). The ups and downs could be expressed as the volatility of the ride, the more volatile the better for the thrill-seekers!

In summary roller-coasters are low risk & highly volatile.

The same can be said of investments, pension funds and whatever else is based on equity/stocks/markets/shares (we’ll sum these up with ‘the stock market’).

The risk of death (total loss of capital) is really low, actually never happened! While the volatility (amount of ups and downs) is high.

What is Risk of My Investments/Pensions?
Risk, by it’s correct definition is the chance of permanent loss of your money (capital). In the history of the stock market this has never happened to a broadly diversified portfolio.

What is Volatility of My Investments/Pensions?
Volatility indicates the liability of the stock market to change rapidly and unpredictably, usually for the worse! We would go one further with volatility, we suggest that it is the movement above and below the stock markets’ permanent upward curve.

What is the Stock Markets’ Permanent Upward Curve?
You may well be saying; ‘This fella is being too optimistic, and simplistic!’. Perhaps. Bear with me a second. What year we you born? 1980, 1970, 1990? Whatever year you were born check out the price of the S&P 500 in that year, and compare it to today’s price of 2,431 (June 2017).

If, like me, you were born in 1980, the S&P was then at 100……despite all the chaos, all the media coverage of ‘the end of the financial world’, ‘the crisis’, ‘the recession’, this bad boy has grown by 20 times since then, 20!

If you were born in 1970, the S&P 500 was at 70 then, it is now 30 times that rate. Born in 1990, it was 300 then, it is now 7 times that rate……get in and stay in!

The permanent upward curve……

What Should I Do About The Risk/Volatility Of My Investments/Pensions/Savings?

Firstly, understand what the volatility is going to result in, what type of falls you should prepare yourself for. Ask yourself if you will be able to sit and hold on to the roller-coaster when the thing falls by 20-30%, that you wont try and jump out of the roller-coaster, that you will be able to wait for it to come back up. If you can’t do that then you are not comfortable with volatility and there’s a risk that you will end up doing something stupid when the roller-coaster dips…..get out now before it dips, or don’t get into it in the first place! If you are in it, and you can’t accept the above then go and find whoever advised you into that, give them a slap upside the head, and tell them how they should have helped you initially………and show them this!

Thanks for sharing & allowing me to create my ‘art’!

Paddy Delaney

QFA | RPA | APA | Qualified Coach

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