The two should not be confused.
What is risk? To the conservative investor, risk is a negative. To
the opportunistic investor, risk is a factor to tolerate and accept.
Whatever the perception of risk, it should not be confused with
volatility. That confusion occurs much too frequently.
Volatility can be considered a
measurement of risk, but it is not risk itself. Many investors and academics measure investment risk
in terms of beta; that is, in terms of an investment’s ups and downs in
relation to a market sector or the entirety of the market.
If you want to measure volatility from a very wide angle, you can examine
standard deviation for the S&P 500. The total return of this broad
benchmark averaged 10.1% during 1926-2015, and there was a standard deviation
of 20.1 from that average total return during those 90 market years.1
What does that mean? It means that if you add or subtract 20.1 from
10.1, you get the range of total return that could be expected from the S&P
two-thirds of the time during the period from 1926-2015. That is quite a
variance, indicating that investors should be ready for anything when investing
in equities. During 1926-2015, there was a 67% chance that the S&P could
return anywhere from a 30.2% yearly gain to a 10.1% yearly loss. (Again, this
is total return with dividends included.)1
Just recently, there were years in which the S&P’s total return
fell outside of that wide range. In 2013, the index’s total return was +32.39%.
In 2008, its total return was -37.00%.2
When statisticians measure the volatility of major indices like the
S&P 500, Nasdaq Composite, or Dow Jones Industrial Average, they are
measuring market risk. Trying to measure investment risk is another matter.
You can argue that investment risk is
not measureable. How can investors
measure the probability of a loss when they invest? Even after they sell an
investment, can they go back and calculate what their risk was at the time they
bought it? They only know if they made money or not. Profit or loss says
nothing about risk exposure.
Most experienced investors do not fear
volatility. Instead, they fear loss.
They think of “risk” as their potential for unrecoverable loss.
In reality, most apparent “losses” may be recoverable given enough
time. True unrecoverable losses occur in one of two ways. One, an investor
sells the investment for less than what he or she paid for it. Two, some kind of
irrevocable change happens, either to the investment itself or to the sector to
which the investment belongs. For example, a company goes totally out of
business and leaves investors with worthless securities. Or, an innovation
transforms an industry so profoundly that it renders what was once a
leading-edge company an afterthought.
Accepting risk means accepting the
possibilities of equity investing. The
range of possibilities for investment performance and market performance is
vast. History has shown that to be true, history being all we have to look at. It
fails to tell us anything about the negative (or positive) disruptions that
could come out of nowhere to upend our assumptions. A “black swan” (terrorism,
a virus, an environmental crisis, a quick evaporation of investor confidence)
is always a possibility. Next year, the performance of this or that sector or
the small caps or blue chips could be spectacular. It could also be dismal. It
could certainly fall in between those extremes. There is no way to calculate it
or estimate it in advance. For the equities investor, the future is always a
flashing question mark, regardless of what history tells or pundits predict.
Diversification helps investors cope
with volatility & risk. Spreading
assets across various investment classes may reduce a portfolio’s concentration
in a hot sector, but it also lessens the possibility of a portfolio being
overweighted in a cold one.
Volatility is a statistical expression of market risk, constantly
measured. Volatility, however, should not be confused with risk itself.
This material was prepared by MarketingPro,
Inc., and does not necessarily represent the views of the presenting party, nor
their affiliates. This information has been derived from sources believed to be
accurate. Please note - investing involves risk, and past performance is no
guarantee of future results. The publisher is not engaged in rendering legal,
accounting or other professional services. If assistance is needed, the reader
is advised to engage the services of a competent professional. This information
should not be construed as investment, tax or legal advice and may not be
relied on for the purpose of avoiding any Federal tax penalty. This is neither
a solicitation nor recommendation to purchase or sell any investment or
insurance product or service, and should not be relied upon as such. All
indices are unmanaged and are not illustrative of any particular investment.
04062016-WR-1597
04062016-WR-1597
Citations.
1 -
fc.standardandpoors.com/sites/client/generic/axa/axa4/Article.vm?topic=5991&siteContent=8088
[3/31/16]
2 -
ycharts.com/indicators/sandp_500_total_return_annual [3/31/16]