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Confusing volatility with risk can cause stress and heavy financial losses. Here, we explain the difference between the two.
12 September 2024 | 3 minute read
One of the most common mistakes investors make is to confuse volatility with risk.
At best, it leads to unnecessary stress and worry, and at worst, it can lead to heavy financial losses. It is therefore vital that investors understand the difference between the two.
Learn how investing helps your money work harder in our jargon-free guide.
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At its simplest, volatility is a way of describing the degree by which share price values fluctuate. In volatile periods, share prices swing sharply up and down, while in less volatile periods their performance is smoother and more predictable.
Risk, on the other hand, is the chance of investments declining in value. How much investment risk you’re able to take on depends on a range of factors, most notably how long you’re investing for.
Interpreting volatility as ‘risk’ is a misjudgement often caused by watching your stock portfolio too closely. In one sense, this is perfectly understandable. The stock market can be a risky place to be in the short term, and watching the value of your life savings jump around from day to day can be gut-churning.
Investing in the stock market requires a long-term perspective. History shows that over periods of ten or more years, equities generally outperform cash.
The graph below shows how different asset classes have performed compared to cash. Any balanced portfolio consisting of a mix of stocks and bonds, for example, would have outstripped cash returns by a good margin over the long term. Of course, investing comes with more risk than holding your money in a cash account, your investments may lose as well as gain value, and there are fees to consider. The best way to preserve your portfolio over the long term is to diversify your investment.
Source:RBC Brewin Dolphin / LSEG DatastreamNeither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance.
The past few decades have seen their share of market volatility. We have endured the recession of 2001, the market bottoming out in 2003, and the financial crisis of 2008/9, when markets were swinging up and down by 4% or 5% a day. More recently, in March 2020, stock markets suffered huge crashes as the spread of Covid-19 led to fears of a global recession.
Investors who took a short-term view may well have made a loss. The key is to remember that, over the long term, share price values tend to bounce back.
Volatility can be a powerful force for good because these wild swings work both ways. For example, our research shows that missing the market’s five best days between December 1971 and August 2024 would have led to a 44% lower return than if you had remained invested throughout. Missing the best 20 days would have reduced returns by a staggering 84%. So, while stock market volatility may be stressful, history shows it is better to stay invested in bumpy times because long-term returns typically outweigh short-term losses.
Getting some financial advice can help you invest objectively and rationally, and avoid knee-jerk reactions. By staying calm and focusing on the long term, you’ll reduce your chances of making a costly mistake.
1 Based on consumer price index (CPI) data2 Based on Bank of England base rates
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The value of investments, and any income from them, can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
This publication has been issued by RBC’s Wealth Management international division in the United Kingdom and the Channel Islands which is comprised of an international network of RBC® companies located in these jurisdictions and includes RBC Europe Limited and Royal Bank of Canada (Channel Islands) Limited. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by RBC’s Wealth Management international division.
This publication has been compiled from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgements as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, the value of investments and income arising can go down, future returns are not guaranteed, and an investor may not get back the amount originally invested. Countries throughout the world have their own laws regulating the types of securities and other investment products and services which may be offered to their residents, as well as the process for doing so. As a result, any securities or services discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law none of the entities which comprise the international division of RBC Wealth Management nor any of their affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBC Wealth Management.
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