Investment volatility is often erroneously assumed to be the same as investment risk and, as a result, something to fear.
You will have already read my detailed analysis of investment risk so, to complement this, I thought it was worth a deeper dive into investment volatility and why it’s actually something to welcome, rather than be scared of.
But rather than you simply having to read my analysis, I thought I’d enlist the help of legendary investment guru, Warren Buffett.
So, all the quotes about investment volatility you can read here were made by him – either in interviews, or in the now-famous annual reports he sends to his Berkshire Hathaway investors.
“If the investor fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things.”
While investment risk can be a problem, subject to the amount you’re prepared to accept to achieve your financial goals, market volatility is a natural part of how markets behave. Consequently, you should welcome it.
In reality, volatility only really becomes a potential risk issue if you decide to cash in any of your investments after they have fallen in value.
In other words, risk is based on how you react to market volatility, rather than the volatility itself.
Whenever you see news reports about a certain event wiping millions, or even billions, off of the value of shares, it can help to remember that that’s only an issue if you happen to be selling them at that time.
History tells us that if you sit tight and do nothing, the price is likely to return to its previous value.
“A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.”
The nature of investment volatility means that it can create great opportunities for you to profit and improve the long-term value of your investment portfolio.
You’ll often see wild swings in the value of individual share prices, or even whole sectors, as they are affected by external events.
An effective spread of investments will help dampen the effect of short-term volatility on your wider portfolio. But as you’re likely to be investing on a monthly basis through your pension, you can benefit when values fall by being able to purchase more shares or investment units with your contribution. As and when the values of those shares and units rise, you own more of them to profit from.
“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.”
Although undated, it’s likely Buffett made this quote after a sudden and dramatic market downturn – maybe when the dot-com bubble burst, or after the financial crash in 2007/08.
Supposed “safer” investments, such as cash or government bonds, can actually come with greater risk than equities.
While there is a place for cash in your financial planning – your emergency fund, for example – holding too much cash in your portfolio is, paradoxically, a high-risk strategy. That’s because inflation is likely to reduce the purchasing value of your cash.
Likewise, bonds can be just as susceptible to the effects of economic activity and bank intervention as investment markets. In particular, they are particularly sensitive to interest rate hikes.
You would have witnessed this in September 2022 when rising inflation caused the Bank of England to increase interest rates, prompting bond prices to fall dramatically.
“Risk comes from not knowing what you’re doing.”
You will have read this a lot in my articles, but it’s a message that bears repeating. As with all major projects, you need a robust plan in place for your finances and investments.
Not only that, but once your plan is in place, you need to stick to it, and not be tempted to make changes as and when you’re faced with problems.
In reality, changing your investment strategy in the event of market volatility is highly risky. A robust plan will have an element of investment volatility factored in to it. By making short-term adjustments you may well jeopardise your future financial security.
“Someone’s sitting in the shade today because someone planted a tree a long time ago.”
You should always see investing as a medium- to long-term undertaking.
Although the make-up of your portfolio is important, successful investing can often come down to a matter of how long you invest for, rather than any particular choices you make or shares you buy or sell.
By holding assets for the long term, you reduce the risk of short-term market turbulence blowing your investment plans off course. You will also benefit from the long-term effect of dividend payments that, when reinvested, will add value to your portfolio through the power of compounding.
If you were in any doubt as to how long you should look to hold investments in your portfolio, one final quote from Warren Buffett will give you a good idea of the time frame you should be considering: “Our favourite holding period is forever.”
Get in touch
If you’d like to know more about managing your investments, then please get in touch.
You can call me on 07769 156 250.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested.
Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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