Investors confusing volatility with risk

At its simplist, volatility is a way of describing the degree by which share values fluctuate.  In volatile periods, share prices swing sharply up and down while in less volatile periods their performance is smoother and more predictable.

Risk on the other hand, is the chance of selling your investments at a loss, and the main factor that differentiates the two is your time horizon.

Interpreting volatility as ‘risk’ is a misjudgement often caused by watching a stock portfolio too closely. This is perfectly understandable; the stock market is a risky place to be in the short term and watching the value of their life savings jump around from day to day can be gut-churning.

But investing in the stock market requires a long-term perspective; history shows that over periods of 10 years or more – it is a very profitable place to be.  Crucially, it almost always outperforms alternative investments such as cash.

Even those that invested in 2000, literally just before the crash, would have seen their money more than double in the years since, although it would have been an extremely volatile ride along the way.

Remember, in that time we have endured the recession from 2001, the market bottoming out in 2003 and the financial crisis of 2008/09, when markets were swinging up and down by four or five per cent a day.  Investors that took a short term view may well have made a loss, but those that kept calm and stood firm have reaped the rewards. The key is to remember that, over the long-term, with remarkable consistency, share values have always bounced back – sometimes in big, rapid leaps.

This demonstrates an equally important point: volatility can be a pwerful force for good because these wild swings work both ways. For example, being out of the market for only the five best days during the past 20 years wouldhave led to a 23% lower return. Missing the best 10 days would have reduced returns by a staggering 40%. So, while volatility may be stressful, experience shows it is better to stay invested in bumpy times. Timing the market with such precision is impossible.

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