Volatility: A Jargon-Free Guide to the Highs and Lows of the Market

volatility

Volatility isn’t just what can happen when you ask your significant other to ‘just wash the damn dishes, for once!” It’s also the term for a measure of risk related to financial securities, including stocks.

Volatility is a measure of risk

But when it comes to investing, risk isn’t always a dirty word.

A higher volatility stock suggests more risk, but may also provide opportunity for a greater return. But remember! Returns aren’t always increases. Your return can be an increase or a decrease in value. A stock with lower volatility generally involves less risk than a stock with higher volatility. Volatile assets are ones that experience large price swings.

Some funds attempt to track indices that are very stable. Our investment Slow and Steady is just that*. It has very low volatility partly because the index that it tracks (PowerShares S&P 500 Low Volatility Portfolio) covers big, stable companies. These companies often have milder highs and lows in the value of their stock than the overall market; it’s right there in the fund name.

You can also think of volatility like  the waves on an ocean. When you’re rowing your boat on the open sea, some journeys are smooth sailing, small waves, pleasant breeze, predictable squawking seagulls… Other journeys to more exotic destinations might require navigating waters that are a bit choppier. If you have a more ambitious destination in mind, you might decide it is worth it to risk the more turbulent waters.

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Slow and Steady, and other low volatility investments, aim to sail along smoother seas to conservative destinations. Check out Slow and Steady’s (ticker symbol SPLV) nice, gradual increase over the last few years*.

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Compare this with iShares NASDAQ Biotechnology ETF, which is chartering choppier waters to a perhaps more ambitious destination. Check out those highs and lows. Or crests and troughs for you biology nerds. ????

volatility

Uncertainty is always a part of investing. No one can predict the future of the market (run the other way if they say that they can!). However, we can investigate the history of a stock or fund’s performance in order to gauge its realized or historical volatility.

There are several ways that investors can measure volatility. Risk and change can be scary, particularly when your money is concerned.

Regardless of the futility of attempting to predict what the market will do, we all want reassurance that we are investing with as much information as we can possibly get. Investing involves risk, after all. We try to predict other unpredictable things in our lives: we check the weather to decide whether to bring along our umbrella, use crowdsourced reviews of restaurants to find the best dinner, and does anyone else take public transit to work? ???? There are also a few ways investors forecast and analyze the volatility of stock prices.

Standard Deviation and the Beta Coefficient are a couple. For this intro-level-look at volatility we want to introduce the Beta Coefficient (or just ‘beta’, as the finance folk say) into your rapidly accumulating Fin-Lit* vocabulary.

*We are fully aware that shortening Financial Literacy to Fin-Lit might come across as a bit cheesy. But we think this stuff is as fun and fascinating as any other literature genre with an epithet, and is deserving of its own catchy nickname.

Volatility: All About Beta

The beta of a stock tells you how volatile it is compared to the overall market.

Fun fact: When someone is talking about U.S. stocks and says ‘The Market’, they generally mean the S&P 500**, the list of the largest companies whose shares are most often traded on the NYSE and NASDAQ.

It can be described as the “statistical measure of a portfolio’s sensitivity to market movements.”

The market’s beta is 1.0. If a stock or fund has a beta of 1.0, its volatility is the same as the market.If a stock has a beta of less than 1.0, let’s say 0.9, it will move at a rate of 90% of the market.

Basically, beta is a tool to help investors make investment decisions based on their risk tolerance relative to the overall market.

For an engaging look at how volatility and risk play into building a portfolio, check out our exploration of asset allocation and the differences between equity and debt.



Footnotes
**The S&P 500® (“Index”) is an index of 500 stocks seen as a leading indicator of U.S. equities and a reflection of the performance of the large cap universe, made up of companies selected by economists. The S&P 500 is a market value weighted index and one of the common benchmarks for the U.S. stock market. The Index is a product of S&P Dow Jones Indices LLC and/or its affiliates. Copyright © 2017 by S&P Dow Jones Indices LLC, a subsidiary of the McGraw-Hill Companies, Inc., and/or its affiliates. All rights reserved.




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*Past performance is no guarantee of future results, and any expected returns or hypothetical projections may not reflect actual future performance. Furthermore, past returns may reflect the performance of assets for a finite time, or during a period of extreme market activity.