Good morning & happy Monday!
The true investor welcomes volatility … a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.
Warren Buffet, legendary investor
Today I would like to talk about the difference between two words, words that are often interchanged in the investing world, but that I would contend are not at all like each other. Those 2 words are:
- Risk
- Volatility
What is risk? What is volatility? Are they the same things?
Risk is defined as “a situation involving exposure to danger.”
Volatility is defined as “liability to change rapidly and unpredictably, especially for the worse.”
They both sound terrifying and on the surface they seem to be fairly similar definitions, but let’s dive in just a little bit further.
If I say “this is a pretty risky investment” that would mean there is a good chance that one could lose money on a long-term basis. Even though I do not at all consider cryptocurrencies to be an investment, I would most certainly consider crypto to be a perfect example of “risky.” What do you own if you have 5 Bitcoin or 10 Ethereum? What profit are those currencies generating? What is your investment objective in holding them? What is the underlying value of them? These are questions that I have a hard time finding answers to and I do not invest in things that I do not understand (a core investing principal of mine).
Volatility on the other hand is a completely different thing. Volatility simply means that something goes up & down, maybe by quite a lot at times. On the surface this seems not at all good, but I believe volatility provides tremendous opportunities and thus should at minimal be ignored and at best be embraced and celebrated. If I buy a diversified portfolio at $100/share and it goes to $75/share is that risky? Nope, just volatile. I have every reasonable belief (backed by history) that the investment will not only return to its $100/share price but go on to new highs from there. History can lead me to no other conclusion. So, with that understanding, if I have the ability to make additional purchases of the portfolio at temporary depressed prices than that volatility is a great thing 😊 About 2 years ago I wrote a Monday morning memo titled “I ♥ Volatility”
One of the best examples I have heard about investing is that it is like a person walking a dog through Central Park in New York City. The dog walker is walking from south to north and the dog is on a long leash. As the person and the dog are walking, they are heading in the same direction, but at any moment the dog may run ahead or behind, sometimes just a little, other times by a lot. The dogs’ actions are not predictable but the general direction the dog and the dog walker are headed is still the same. Investments are the dog, they bounce around and may appear to be going the wrong way at times, but the dog walker is market fundamentals that historically have always been able to bring the dog back on the path in the right direction.
Anything that reduces volatility simultaneously suppresses returns. If I have a portfolio with 50% stocks and 50% bonds I will have less volatility than a portfolio of 100% stocks, but that also means my returns overtime will also be lower. Is that a good trade off? Depends on how much volatility an investor can handle. Personally I am a very aggressive investor, which means I am very comfortable with significant volatility in my pursuit of high long-term gains, but that is not at all the same thing as being a risky investor. Make sense?
As the cost of everything increases over time (at elevated levels right now) the risk we all face is that the value of our dollar decreases over time. This is a real risk. 2 years ago if I had a $50 bill and went to the gas station I would be able to fill up my tank and have $20 left over. Now that same $50 bill gets me less than ¾ of a tank. Over time our money simply becomes less and less valuable. We invest with the objective of keeping up with and beating inflation on a long-term basis. Volatility is the price we must pay in order to achieve that objective.
Like a broken record I will continue to say: stay the course, stick to the plan 😊
Thank you for the tremendous honor to serve you. At any point, please do not hesitate to reach out to me or my team if we can be of assistance.