Volatility is not a risk, use it to improve portfolio returns
At a recent get-together, this writer was party to a discussion on what else but the markets.
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The topic veered around market volatility, and one person quipped that the biggest risk in current times is volatility.
Most people believe that if the market's going wild, it means there's a lot of risk.
So, they get cautious when deciding where to put their money based on these short-term swings.
But here’s the thing - high ups and downs don't always mean danger, especially for those looking at long-term investing.
Some investors panic every time stock prices swing!
But, you know what?
People often mix up the whole volatility thing with real investment risk.
That's a mistake.
We tend to miss out on this crucial distinction when we focus too much on those short-term market jitters.
We need to understand that these swings don't define actual investing danger – no way!
They might be part of the journey but aren’t indicative of potential growth or losses when viewed from a broader perspective.
Understanding Volatility and Risk
Volatility represents the degree of variation in the price of a financial instrument over time.
It's a statistical measure of the dispersion of returns for a given security or market index.
While volatility is observable and quantifiable, risk is a more abstract concept.
Risk is the likelihood of an investment not meeting the expected outcome.
The critical error many make is conflating these two distinct concepts, treating volatility as a proxy for risk.
The Financial Industry's Focus on Volatility
Financial firms thrive on trading activity, which volatility can spur.
It's a tool to prod investors into action and look at trading opportunities.
Volatility creates opportunities for traders to take short-term calls and profit from price swings.
Derivatives, options, and volatility trades focus primarily on short-term investment outcomes rather than sustainable, long-term wealth creation.
Beyond Volatility
Leaning on volatility as a decision-making tool in investments often means allowing luck to dictate the outcomes.
In contrast, a deep understanding of risk and a well-thought-out investment plan can steer investors towards more controlled, deliberate paths to achieving their financial goals.
Long-term investment success hinges on recognizing and planning for real risks, not reacting to market volatility's ebb and flow.
Investment guru Warrant Buffett believes the long-term investor can use volatility profitably.
Buffett said it is hard to understand why the availability of such bargains should be seen as increasing the risks for investors who have the total liberty to either overlook the market's swings or capitalize on its lack of rationality.
For those focused on building wealth over time or saving for specific goals, the market's volatility should not trigger undue concern.
Instead, investors should employ simple, effective tools and strategies that align with their long-term objectives.
Conclusion
Volatility is not a risk in financial markets, at least not in the way many perceive it to be.
It is, however, a facet of the markets that can serve as a useful measurement for short-term speculators.
For the long-term investor, understanding the difference between volatility and real investment risk is paramount.
This distinction is crucial for navigating the financial markets with clarity and purpose, ensuring that decisions are made with an eye towards sustainable wealth creation, rather than being swayed by the transient winds of market volatility.
In doing so, investors can turn their focus away from the noise and towards the nuanced, strategic planning that true financial growth requires.
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