How Volatility Affects Investment Success
You don’t have to be a financial planner or analyst to know that the stock market ebbs and flows. But it would be wise to know why this phenomenon, known as volatility, happens and what it means for your investment success.
Let’s start with the basics.
What is Volatility?
As a measure of risk (uncertainty of loss), volatility refers to the amount of fluctuation in returns, and is typically stated as standard deviation. Rapid fluctuations in a short period of time mean high volatility, which is often caused by economic, corporate, and political changes.
Why Volatility Matters
Not to be ignored or considered par for the course, volatility has real impacts on your investments. How? Volatility diminishes compounded returns over time. As volatility increases, a portfolio’s compound returns (which is the money you eventually get) decrease. And this gets riskier and riskier the closer you are to retirement, as your portfolio has less time to bounce back. This could mean retirement delays if you don’t act quickly.
How to Minimize Volatility Risk
Diversification, or having a wide variety of investments within a portfolio, is often seen as a way to minimize volatility risk. The idea being that the good investment performance can balance the bad. But this doesn’t always work as intended. When it comes to minimizing volatility risk, you must think back to what affects volatility – often economic, corporate, or political uncertainty. And in these times of uncertainty, markets that may seem unrelated tend to act the same. Thus your diversification fails to protect your investments when needed most.
Debt funds are less prone to volatility than equity. However, there is a choice to make between short-term versus long-term debt, or income funds and dynamic bond funds, respectively. While dynamic bond funds can produce bigger wins, short-term debt offers a steadier return on investment with lower risk. Sometimes slow and steady wins the race, especially when you consider compounding returns.
Long-Term Investment Planning
Just because an average stock return is a certain percent doesn’t mean you will immediately realize that return. In fact, actual returns tend to fluctuate significantly higher and lower than the average. This is why it’s important to plan with the long-term average in mind. The long-term outlook allows good years to outweigh and balance the bad, eventually achieving the averages. However, reducing risks and volatility will be an important factor in reaching that long-term average and increasing the consistency of investment returns, which requires smart investment planning.
At JarredBunch, we support the use of financial models as the foundation for your investing strategy to help manage risks while capturing opportunities. This goes beyond traditional financial planning and portfolio management to provide a larger picture of a client’s financial life and needs. Our models help clients make smarter investment choices that reduce volatility risk, ultimately putting your investments to work for you – the way it should be.
Ready to take the next step? Drop us a line if you have questions or want help reaching your full financial potential.