Jargon Buster: What is Volatility?
If you read our previous jargon article, ‘Finance Jargon and The New Investor,’ then you’ll be aware that the terminology often used when discussing investing can be somewhat confusing. With this in mind, we wanted to create a series of blog posts to help investors learn more. We’ve decided to start with the term, ‘volatility.’ This word can often be misunderstood, but once it’s been explained correctly, you’ll see that it’s actually quite simple.
What is Volatility?
Investment professionals continually talk about volatility as a measure of risk. Volatility is calculated by a measure known as ‘standard deviation’, which is a measure of the difference between two sets of values. This single measure gives investment professional investors a clue about a range of possible outcomes. For example, if a multi-asset fund, let’s call this Fund A, has a volatility of 6% and delivers an average return of 3%, the fund daily price will likely have risen by as much as 9% and fallen by as much as -3%; with lots of smaller up and down movements along the way. Day to day this means your pot of money moves up and down in value, but if you do not intend to draw on it anytime soon then these price moves may not be of great concern to you. However, this isn’t true for everyone and it is why our investment partners go to great lengths to manage volatility in a way that suits clients’ specific requirements.
Risk and Return
Within investments there is a trade-off between risk and return. The higher the risk or the more volatile the investment is the greater the return which is required by an investor to compensate for the risk taken. However, the future outcome of this cannot be predicted with certainty. This is because prices shift with changing investment conditions.
Historically, volatility changes, we go through times of both high volatility (fluctuation over a short time span) and low volatility (fluctuation over a longer time span).
Political and economic factors often influence volatility, for example volatility increased around the time of the Brexit result. However, by planning ahead with our fund manager partners, we aim to mitigate increased volatility’.
Our True Potential Portfolios achieve multiple layers of diversification by selecting multi-asset funds that invest in a broad range of assets covering multiple geographic regions and diverse investments styles. Having a portfolio that is well diversified, such as the advanced level of diversification used in our True Potential Portfolios, this could potentially reduce the impact of any one particular risk on your investments. As with all forms of investment, you cannot make risk disappear altogether.
As with most finance jargon, the term ‘volatility’ needn’t be a one you shy away from. Once you understand the meaning behind it, the better equipped you’ll be to fully understand the performance of your investment.