Investments are nearly always a large part of the recipe most successful people use to build and secure their wealth. The compounding return and consistent success that the stock market has yielded with almost 100 years of highly reliable data showcase the powerhouse that financial markets are!
However, understanding risk, volatility, and the importance of clear financial goals helps us overcome the fear of a down stock market. After all, markets, sectors, and countries experience rises and falls in their performance. It is not a straight line up!
Understanding the Difference Between Risk and Volatility
Risk is the uncertainty of the performance of an investment; thus, greater uncertainty often leads to greater returns. This is the case with the stock market. The returns we gain from the S&P 500 are reflected in the expectations of future success of the companies within the index. Many factors are analyzed when considering the success of those companies.
In comparison, government bonds (considered low-risk investments) only depend on the U.S. government’s ability to make interest payments to bondholders. This example illustrates why greater returns are seen in the stock market—greater uncertainty generates greater returns.
Volatility, the degree of variation in the price of an asset over time, is closely correlated with risk. A riskier asset will see greater price fluctuations. Uncertainty surrounding an asset also causes volatility. This uncertainty can come from a specific company’s decision or performance around their product or services, among other things, as well as uncertainty about the general economy or their specific market, often contributing to stock prices being volatile.
How To Better Adapt to Market Volatility
1. Understand How Your Investments Behave in a Volatile Market
While it is hard to pinpoint a quantifiable measure to the risk of your investments, certain analyses and equations help us to do so. One such analysis is beta. Beta is an analysis that helps us understand how a particular stock moves in comparison to the rest of the stock market, which has a beta of 1. If a stock has a beta of 0.5, this means that when the stock market is down 1%, our stock is only down 0.5%.
On the other hand, if the market is up 1% our stock is up by 0.5%. Understanding the beta of your portfolio can help you understand how volatile it is.
2. Behavioral Finance
Behavioral finance is the study of behavioral decisions within finance under stressful situations. Understanding certain behaviors that we exhibit under stress can help us avoid rash decisions in a particularly volatile time. One identified behavior is loss aversion: when one undervalues gains of equal or greater size than a recent loss. Markets are up 53% of the time and usually see greater gains than losses on the days that they are down.
With volatility driven by current events, recency bias, which gives greater weight to recent events in decision-making rather than long-term trends, is common. Many investors will have such thoughts, but as they are recognized and addressed, uneducated decisions are avoided, and financial goals are closer to achievement.
3. Analyze Historical Performance
Despite short periods of volatility, corrections, or even recessions, the stock market has always recovered. For example, in the 2008 Great Financial Crisis (GFC), the S&P 500 dropped about 57% from its previous high. Despite this massive drop, in five years it recovered to its pre-GFC highs. After another five years, it went up 79% more. Time is on our side.
For younger investors, this is great news, but for those near or in retirement who may not have 10 years. In this case, it is crucial that you analyze the risk of your investment portfolio, as mentioned in the first point. Any great advisor will consult your age and risk tolerance to help you enter a proper portfolio for your age and risk tolerance.
Invest with Confidence—and the Right Guidance
Risk and volatility have been and always will be considerations when investing. To ensure you are on the right path, speak with a financial advisor about your financial goals, how to accomplish them, and how to invest, accounting for risk and volatility.
The stock market is a remarkable tool for building and securing your wealth. Those that can harness the wealth-generating power of the stock market have profited greatly over the last 100 years. Those who have market timed, or have deployed track-record investing, have been harmed. With the right coach, the right financial advisor, you can build and secure your wealth and feel completely confident and settled in how your money is being managed.
Talk to a financial advisor from Tencap today!
Disclaimer: The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services to any residents of any State other than the State of Utah or where otherwise legally permitted. All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication of future results. Moreover, this material has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed. Purchases are subject to suitability. This requires a review of an investor’s objective, risk tolerance, and time horizons. Investing always involves risk and possible loss of capital.
Nick Carrigan
Nick trains and develops families in creating, maintaining, and growing wealth. This includes educating clients on the science and academics of investing, comprehensive financial planning, and ongoing coaching to ensure discipline for a lifetime. Nick has seen this create incredible levels of freedom, fulfillment, and love for the families he works with.
