Volatility reflects the daily ups and downs in the value of investments. Much maligned by investors and the media when prices plummet, volatility is welcomed when investment values head upward. Yet, when was the last time you heard anyone use the word "volatile" to describe prices going up?
How volatility differs from a roller coaster
Volatility is often equated with riding a roller coaster, but there's one key difference. When your roller coaster ride ends, you´re exactly where you started.
Stock values have trended higher over the long term despite steep periodic declines. From a long-term perspective the declines don't look nearly as steep as they probably felt at the time.
Living with volatility's downside
Most people can get reasonably comfortable with volatility by using 4 basic investment strategies:
- Focus on the long term
- Invest regularly
- Diversify your investments
- Keep in touch with your financial advisor
Focus on the long term. One key to living with volatility is focusing on long-term results rather than the daily bumps along the way. This can be especially difficult during prolonged market declines fed by daily injections of bad news.
Invest regularly. Also called rupee-cost averaging, an automatic investment program is another strategy for living with volatility's downside and taking advantage of its upside. You don't need to worry about the best time to invest when you put away the same amount every month, but like most investing strategies, it doesn't guarantee a profit or prevent losses and some people find it difficult to continue buying shares through prolonged market slumps.
Diversify your investments. None of the asset categories does well all the time, so it can be a good idea to put your eggs in a variety of baskets. If some of your investments are down, others may be up.
Keep in touch with your financial advisor. Our last strategy for putting volatility in perspective may be the most important. Financial advisors are trained to focus on your financial goals, your time frame and your comfort with volatility
Volatility is how risk manifests itself, so all the common "risk" measurements that you'll see below actually gauge how volatile an investment has been in the past not how "risky" it is.
It's not enough to evaluate a fund based on performance alone. Financial professionals must also look at its risk-adjusted return, especially for clients with time frames of less than 10 years or those who are very uncomfortable with volatility. That's why advisors also look at common volatility measures such as R-squared, beta Sharpe ratio and standard deviation.
All risk measures have limitations. First, they are based on past performance. Second, no single measure paints a complete picture of risk. Investors should also consider qualitative risk factors such as investment style and portfolio concentration.
Keep in mind that investing is not solely about numbers. Nor is it about "avoiding" risk. These measures are intended to help you understand risk.
