Risk vs. Volatility: How Knowing the Difference May Help You Make Better Financial Decisions

Risk and volatility. When it comes to the financial world, these words are often used interchangeably to describe market fluctuations, especially downturns. In our experience, however, they can indicate two very different occurrences, and knowing how to distinguish between them can position you to make decisions that may better serve your long-term financial goals.

What is market volatility?

Volatility is a term used to describe short-term changes in stock prices. The changes can sometimes be dramatic, resulting in a significant spike or sharp decline. The important thing to note is that these fluctuations happen all the time, and more often than not are temporary.

They are so common, in fact, that there’s a name for the type of market rollercoaster that involves a steep drop immediately followed by a quick return. It’s called a “v-shaped bottom,” and we saw an example of this just last year, when the S&P plummeted 20% between September and December, only to rally again by April of this year.

Where does risk come in?

Because volatility is such a constant, short-term market fluctuations can often be waited out by investors who focus on long-range planning.

Too often, risk is heightened when investors make important decisions not based on a long-term plan but on short-term highs and lows. This can lead to serious loss when investors react with over-enthusiasm or panic to short-lived changes in stock prices.

What does this mean for investors?

When planning for your financial future—whether that is your retirement or the legacy you will pass on to your children—basing decisions on an emotional reaction to what is often a temporary reality can lead to devastating loss. An investor who sells everything in a moment of panic over falling prices may find that there is insufficient time to rebuild lost wealth.

On the other hand, an intentional, long-range approach to planning can increase the likelihood that you will have the resources you and your family need for years to come.

Investor behavior is a key factor in successful investing, oftentimes playing a larger role than even portfolio design. To learn more about long-term financial planning for your unique goals, contact me for a consultation.