Volatility & Risk – a clear difference

We felt it was worth taking a moment to explain the current financial market conditions which have clearly seen a ‘sell-off’ since the start of October, which many fund managers have commented on but for me, the key is for my clients to understand that there is a clear difference between volatility and risk.

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

I do hope this helps and be assured, my commentary above is echoed by the fund managers and Investment houses so all round, the current conditions are being closely monitored, not just to manage losses but with the intention to capitalise on opportunities.

Please email or call Alison (07496 689 309) or Adrian (07725 343 815) for a no obligation review of your circumstances.