| Does volatility necessarily imply risk? |
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Investors often associate volatility with risk, avoiding investments that experience volatility – like equities – in order to avoid risk. But does volatility always imply risk? Not necessarily, says Marius Fenwick, Chief Operating Officer of Mazars Financial Services.
“Investors have little control over volatility, which is a normal part of investing. Risk, on the other hand, is about losing money permanently, and is determined on the day you disinvest. Investors can exercise some control over risk first by carefully considering when to disinvest and, second, by not getting into the wrong investment to begin with,” says Fenwick.
Volatility is a well known characteristic of equities, and is the relative rate at which the price of a share moves up and down. But that doesn’t mean equities are overly risky. Over the long term they typically deliver positive returns; but not in a straight line. “If you disinvest when the market is down, you’re likely to lose money,” says Fenwick.
Investors can also help determine their own risk by having realistic expectations. If banks are paying interest rates of 7%, this is the current risk-free rate. If you want returns of 20%, you have to incur significant risk in order to make up the missing 13%. “The higher your expectations, the higher your risk of losing capital” says Fenwick. “And this is where pyramid and ponzi schemes come into play, as they thrive on people with unrealistic expectations. Unfortunately those who can least afford to take risks, pensioners and the poor, normally get caught.”
Another way to manage risk is to diversify your investments, either across different asset classes or across markets, or both. Right now, for example, investors are diversifying into undeveloped markets in order to protect themselves from developed markets because they’re experiencing worse effects from the worldwide economic downturn.
Finally, Fenwick says that investors can also look at types of companies to manage risk. If the economy is in recession, it’s less risky to invest in large, blue-chip companies that are more likely to weather the storm. Whereas when a market starts to turn positive, investing in smaller companies can produce better returns as they’re likely to grow faster as the upturn gains momentum. |
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