The Difference between Volatility and Risk

Volatility and risk are two terms that are often confused. For many would-be investors, these words strike fear into the heart, conjuring images of plummeting stocks and lost life savings. The real picture, however, is far less dramatic – and much simpler to understand. While volatility reflects the changeable nature of the stock market, where stocks rise and fall during periods of economic stress or uncertainty, risk refers to the prospect of selling your stocks for less than you bought them. What often sets these two apart is the length of time you’re willing to wait to recoup your investment, and what rate of return you’re hoping to achieve.

Is volatility a good thing?

In a nutshell, volatility means greater opportunity to increase the value of your investments. Just as stocks can fall, they can also rise considerably, opening up the possibility of profiting from these swings. Some stocks will be more volatile than others, but that doesn’t necessarily mean they are riskier. The degree to which you open yourself up to volatility is a personal decision, usually calculated according to the amount of time you’re willing to ride the wave, how good you’re likely to be at controlling your emotions along the way, and what level of return you can ultimately expect.

How do you measure volatility?

Volatility is usually measured according to how frequently, and by what margin, an investment swings away from its average rate of return. The more volatile the investment, the further it will stray from this baseline. For most inexperienced investors, volatile stocks are seen as too dangerous for short-term investments, as they inherently carry with them a greater risk that some or all of your money will be lost. For long-term investments, however, this risk is mitigated over time.

Playing the long game

In order to profit from volatility, you will invariably need to stay invested for a number of years. Investing over a period of 10 years or more tends to result in considerable growth – often much more so than cash investments, which can struggle to keep up with inflation. With these long-term investments, it’s important not to focus too much on individual swings up or down, as panic selling when prices are low will turn volatility into risk instantly. Even in periods of great economic strain, such as a recession, investments can still ultimately increase in value over time. 

Risk and return

Risk and return are inextricably linked. In order to grow your investments, you must open yourself up to some degree of risk. One way to balance the two is by creating a diverse portfolio of investments that carry with them different levels of risk. It’s impossible to predict which stocks will increase (or decrease) ahead of time, so spreading your money across different investments is a good way to protect against unacceptable levels of risk. Investing in some highly volatile stocks may reap great rewards, but most people would be unwilling to stake all of their savings solely on this type of investment. A balanced portfolio not only protects against high levels of risk, but also opens up the possibility of simultaneously profiting from different types of investments and different sectors. 

Working out which investments offer the right balance of volatility and risk is ultimately a personal decision, based upon your financial situation and objectives. We are perfectly placed to offer expert advice and guidance in creating the perfect portfolio of investments to suit your specific needs.

This short guide should be enough to get you started on the road to successful equity investing. Please fill out your details below to download a free PDF version or contact us at [email protected]

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