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One of the stranger paradoxes in finance is volatility — the degree to which an asset’s price swings up or down over time. Most investors hear the word and flinch. But once you understand what volatility actually is, and what it makes possible, you might start to see it very differently.
Think about it this way. A savings account is about as predictable as it gets, your money sits there, safe and stable, and grows at a modest rate. No surprises, no drama. But that predictability comes at a cost. The returns are so low that for most people, saving alone will never build the kind of pot needed for a comfortable retirement. You’d have to put away enormous sums just to get there.
This is where volatility enters stage left. The very reason stocks, property, and other investments can deliver far greater returns over time is precisely because their prices move around. That uncertainty, the chance that things could go down, is exactly what creates the opportunity for them to go up significantly. Investors are essentially rewarded for tolerating the bumps in the road.
In other words, volatility isn’t the enemy of your wealth. It’s the engine that creates it.To my mind, volatility gets such bad press largely because of how it feels at the moment. When markets drop, it triggers something deeply uncomfortable in us, an annoying voice that says “get out, get out now, otherwise we’re all doomed!”
This is our ancient survival instincts doing us absolutely no favours in a modern investment context. Our brains were not exactly designed with a 30-year retirement horizon in mind — they’re more comfortable thinking about clubbing that furry critter over the head for dinner. And the hunt was never predictable. Some days you came back loaded, some days you didn’t. That unpredictability felt like danger, because back then, it was. The intellectual ape never quite got the memo that sometimes the wisest move is to sit still and wait.
In reality, Volatility is essentially that friend who shows up to the party, knocks something over, and suddenly everyone’s questioning whether they should have been invited at all. But that same friend is also the one who always comes through when it matters. They’re just a little chaotic in the short term.
The investors who build real wealth over time aren’t the ones who avoided volatility, they’re the ones who stopped flinching at it. They understood that a portfolio going down 15% in a bad year isn’t a disaster. They might feel a bit green watching everything turn red. What matters is staying the course long enough for the recoveries, and the growth beyond them, to do their work.
So the next time markets get choppy and every headline is screaming panic, remember: volatility isn’t a flaw in the system. It’s a feature. Your slightly chaotic, occasionally alarming, ultimately indispensable best friend. And without it, we’d all be stuck comparing savings account rates and dreaming of a retirement that takes a lot more money to achieve without volatility riding to the rescue.
Volatility is one way active market players can make money with a degree of confidence. Some good companies that are volatile still have fairly recognizable peaks and troughs. And people who track these companies can do really well over time if they buy during known troughs, and sell during peaks, as long as they don’t get too greedy. While markets shocks can interfere, slow and steady in stable markets can pay off when one takes profits in smaller bites.
Mark, thanks for another thoughtful article.
Basically along the same lines as you, I get very frustrated when people use the words “risk” and “volatility” interchangeably.
My own personal way of viewing risk (which I’m sure is not technically correct) is the probability that at the end your investment period, returns will be below a particular threshold level. Volatility along the way doesn’t matter, as long as the return by the end meets your base level expectation.
Greg. I really think people get confused because they simply can’t wrap their head around the difference between risk and volatility. Years ago I read something like this about the difference. Volatility is like a stormy sea, it’s a rough ride, but the ship is fine. Risk is a hole in the hull, the ship is actually going down.
I feel the same way – stock market volatility is not necessarily risk – it depends on goals and timeline.
I think alot of this stems from a lack of understanding about what risk is and how to assess it. My definition of risk is anything that could prevent you from achieving your goals. This means before you can assess risks you need a goal (what do you want to achieve and when?) and a plan (how are you going to get there)? to achieve that goal. Only then can you really start to assess risk (what could go wrong?) and mitigate it.
For investors with long term goals – volatility is truly an opportunity. In that situation the biggest risk isn’t the volatility itself but one’s adverse emotional response to it. Once you learn to control that instinctive fear of a market downturn or understand the root cause of that fear and address it, you will be in much better shape.