“Risk” and “volatility” are popular terms used in the financial market. Confused on what they really mean and what’s the difference between the two. This article is aimed at driving home these concepts.
Let’s understand the difference between Volatility and Risk.
“Volatility is mathematical, Risk maybe psychological”
“Volatility” is a “Financial jargon”. It refers to the upward and downward trend swings in market indices/interest rates, on which an investor will have little or no control at all. Whereas Risk, on the other hand, is a personal matter like possibility or chance of an injury, loss or hazard, or how much financial uncertainty an investor can tolerate.
Measuring Risk and Volatility
A volatility in stock market can be measured in multiple ways. The simplest perhaps is the difference between the maximum return and the minimum return. But the more accurate method preferred by analysts is to measure using “Standard Deviation”.
Standard deviation indicates how much a stock market index varies from its average, both on the upside and the downside.
But in case of risk there is no such measure to calculate. In financial terminology risk refers to the potential permanent loss of money. Technically risk tolerance means different things to different people. “You don’t really know your tolerance for risk unless and until you have knowingly been through it.
How to best understand the difference
When it comes to market, age plays a vital role in connecting risk and volatility. In theory, the younger you are, the less risk affected you will be with volatility. You can set your sights on long-term goals, more or less ignore the market’s fluctuations and trust that investment will yield good return as you have time on your side. As wisely said market and climate both are alike; when it will turn in your favor no one knows, conversely, the closer you are to the age of retirement, the more vulnerable you are to volatility.
Are financial markets the only sector where you face risk and volatility? Do think again.
Going by that principle, aren’t PPF and other interest-bearing investments also volatile ? Isn’t their return change, due to interest rate fluctuations? Don’t banks revise their rate of return on Fixed deposits every quarter to adjust the volatility? At the same time, equity prices are known for its fluctuations. But just because prices fluctuate does not mean there is a risk of loss.
So, how you cope with the impact of volatility on your risk tolerance? First of all be honest to yourself in terms of investment and stop acting on impulse. If you can’t digest the volatility then don’t invest in volatile avenues. If you think you need support please contact your financial advisor who is far more equipped with knowledge and tools to guide you to take an informed decision rather than you ending up taking a rash move.
What an investor should do
Volatility does not imply risk of loss. Volatility simply refers to the price fluctuation. Finally if you want good returns you need to take risk just as we take it when it comes to career or for that matter many decisions in life. The mantra is, just explore the unexplored and you will find the treasure you are looking for. But do keep in mind that some investments may be more volatile while others may be less, which one to choose from is purely based on risk appetite an investor.