20 Jun 2022
It’s not easy navigating the world of investments and as an investor, volatility and risk can often blur into one. Stock market volatility is a normal aspect of investing, but at times it can become heightened, generally due to uncertainty, which can be influenced by many factors such as interest rate changes, inflation rates, industry changes and national and global events.
Heightened volatility essentially describes when a market or security experiences periods of unpredictable, and potentially extreme, price movements where share prices can swing wildly up and down. Volatility is measured by the standard deviation of logarithmic returns – how tightly the price of a stock is clustered around the mean or moving average. It’s also referred to as the continuously compounded return since the frequency of the compounding is irrelevant, making the returns of different assets easier to compare.
Risk is the chance of investments declining in value or in other words – the capacity for loss – and it affects every investment decision we make. Larger standard deviations involve greater risk since the potential for gain and loss is increased. If the range of returns falls into the classic expected distribution of the bell curve, 68% of returns are expected to fall within one standard deviation either side of the mean and 95% of all expected returns within two standard deviations either side of the mean. How much investment risk an individual is willing to take will vary of course and is dependent on a range of factors, most notably how long they’re investing for. With the expected return outlier figures for the up and downside detailing the best and worst scenarios, individuals have the tools to decide on the best investment path for them.
Stock markets are continuing to experience heightened levels of volatility and bond markets, historically more benign, are following this trend. Is volatility a bad thing? We tend to associate the word ‘volatility’ with negative outcomes, but history shows us that rising markets have been just as volatile as falling markets. Volatility generates the expected return outcomes and, when it comes to investment decisions and steering clear of heavy financial loss, getting to grips with the difference between volatility and risk is key.
When we look at the last 20 years, we’ve lived through a recession in 2001, a market crash in 2003, a financial crisis in 2008/9 and a huge shock to markets due to the Covid-19 pandemic in 2020. Despite these events, good days in the markets have significantly outnumbered the bad. Over periods of ten years or more, equities generally outperform most asset classes and with a longer-term approach and a notion of timing, you can ride out volatility and cash in on the brighter days.
Volatility may seem scary, but the wild swings can of course represent great returns as well as copious losses. People often think about volatility only when prices fall but it can also represent sudden price rises. History shows that it’s better to stay invested in turbulent times because long-term returns typically outweigh short-term losses. Holding your nerve in this environment generally bears fruit.
What’s the alternative to investing in the stock market? You could spread your money across banks and building societies, but you’re unlikely to get a real return as your assets are likely to devalue against inflation. Over the long-term, share price values tend to bounce back – stock markets in Europe and the US hit record highs in the spring of 2021, just a year after Covid-19 hit western shores. All investment carries risk but multi asset funds, or a balanced portfolio comprising a diverse range of asset classes carefully selected and blended together, can represent a long-term prudent investment opportunity with potential.
Volatility is part and parcel of investing and without volatility we wouldn’t have the highs that generate returns. The amount of risk an investor is willing to take varies and even with appropriate risk-mapping, there may be times where you’re biting your fingernails, but one thing is for sure – if you’re not even in the game, there’s no way you can win it.
Dominic Brooks, MPS Accounts Manager South
Katie Poulson, Client Engagement & Marketing Manager
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