“Using volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return.” Charlie Munger
Risk is a difficult concept for many investors to grasp. Risk in the minds of many investors is frequently defined as volatility, which is how much an investment returns might vary over time. And, what investors must embrace the fact that volatility is a natural and normal characteristic of equity markets. Nevertheless, because it is normal doesn’t always make volatile markets easier to accept.
Emotions can often play a big role in investing decisions, especially during down markets. In financial circles, volatility is a measurement of the fluctuations of the price of a security. It is essentially an analysis of the changes in the value of a security. It is one of the most key measures in quantifying investment risk.
Volatility is a temporary concept consisting of sometimes mild to wild short-term market fluctuations that passes with time. Most people see it as an excuse to act. Volatility of equities and equity markets are facts of life that will never go away. Since the end of WWII, the equity market has annually declined more than ten percent on average.
Furthermore, the equity market has declined at least 15% an average of once every three years. And it’s declined at least 20% an average of once every five years. It is safe to conclude that the future will not be much different, according to Nick Murray. He stresses that “the U.S. equity markets can be inherently volatile in the short term. This is the primary reason for investors to hold equities and invest for the long run.”
Stock returns generally follow corporate earnings over the long run. In the short run, though, stock prices can be decoupled from corporate earnings and the economic realities that exist at the time.
Mr. Market
“The true investor welcomes volatility … a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.” Warren Buffett
In The Intelligent Investor (1949), its author, Benjamin Graham, introduced a hypothetical character called “Mr. Market”. He described “Mr. Market” as being “schizophrenic in the short run, but rational in the long run.” “Mr. Market” was also described as being “a voting machine, based on belief and emotion, in the short term and a weighing machine, based on facts and objectivity, in the long run.”
In general, investors prefer returns that are relatively predictable, and thus less volatile. In truth, stock market volatility is never fun and tends to make retail investors anxious. It may be tempting to stop the pain by getting out of the market. But don’t fall into the trap of trying to time the market.
Remember market’s long-term returns are positive. Keep your eyes focused on the long term and remember that successful long-term investing requires having the discipline to stay invested through the inevitable ups and downs you will experience.
Volatile Markets
“Stocks take the stairs up and the elevator down.” Wall Street adage
Stock market volatility measures fluctuations in stock prices. A security with high volatility means that its price can fluctuate considerably over a very short period. In contrast, a low volatility means that the price of a security will not change dramatically in short periods of time.
In times of high equity market volatility, it is important to:
- Stay focused on long-term financial goals
- Ensure allocations are consistent with longer-term risk profile and rebalance portfolio periodically.
- Make sound investment decisions based on informed, rational reactions to news headlines.
Keep in mind, if you have 20 – 40 years horizon to invest, a bear market is noise to a long-term investor and should be ignored. In fact, it should be celebrated, since stocks will be on sell. On the other hand, a stock market crash that starts the day after you retire can cause a permanent lifestyle impact if all your money is invested.
When the market is chaotic and market volatility is in hyper-drive over the latest inverted yield curve that may or may not predict a recession, or other temporary headwinds, just remember that it doesn’t represent a threat to any long-term investor, as long as they remain calm and disciplined.
Markets don’t move in a linear fashion but instead move through periods of loss and gain. The gains an investor can realize over the long term — even through periods of market volatility — has been an investor greatest ally.
References:
- https://marketbusinessnews.com/financial-glossary/volatility/amp/
- The Intelligent Investor by Benjamin Graham (Rev. Edition, 2003).
- Ameriprise Market Insights – Market Volatility