What is volatility and risk

Risk defined by us

For us, risk is about the potential for losing money or experiencing severe underperformance. In simple terms, it's the chance that an investment will not meet our expectations or that we might lose the money we invested.

For example, if we invest in a stock and its value drops significantly, or if it doesn’t grow as expected over a long period, we consider this to be risky. This definition focuses on the long-term outcomes and the possibility of not achieving our financial goals.

Risk defined by all other advisors

Many people equate risk with volatility. They believe that if a stock's price moves up and down a lot, it is inherently risky. This perspective focuses on the short-term fluctuations in stock prices.

If a stock shows dramatic price swings, it is often labeled as risky, regardless of its long-term potential. This definition can cause confusion because it conflates temporary price movements with the actual potential for loss.

Volatility defined by us

We define volatility as the amount a stock's price swings up or down each day. It’s a measure of how frequently and significantly the price changes over a short period.

Volatility is a natural part of the stock market and reflects the varying opinions and reactions of investors to news and events.

A highly volatile stock might experience significant price changes in a single day, while a less volatile stock remains relatively stable.

Volatility defined by all other advisors

Others often define volatility the same way they define risk. They see a stock that moves a lot and immediately consider it risky.

This perspective doesn’t differentiate between short-term price movements and the long-term potential for loss or gain.

By conflating these concepts, they miss the nuanced understanding that a stock can be volatile without being fundamentally risky.

What makes us think our interpretation is right

Consider investing like a journey by car. Imagine you're driving to a beautiful mountain resort. The road is winding and sometimes bumpy (this represents volatility), but you know the destination is worth it. Along the way, you might encounter sharp turns and steep climbs, but as long as your car (representing the stock) is reliable and you reach your destination (achieving your financial goals), the bumps and turns are just part of the journey.

In investing, the key is not how much the stock moves day-to-day but whether it reaches your long-term goals. High volatility can sometimes lead to high returns, just as a winding road can lead to a beautiful destination. What matters is the overall performance and whether the investment helps you meet your financial objectives.

Let’s take NVIDIA as an example. Over the past decade, NVIDIA's stock has experienced significant volatility. There were times when the stock price dropped sharply due to market conditions, changes in the technology landscape, and competitive pressures. However, those who focused on the company's long-term potential, innovation in graphics processing units (GPUs), and expansion into artificial intelligence (AI) and data centers have seen substantial returns. Despite the bumpy road, NVIDIA reached new heights, proving that volatility does not necessarily equate to risk.

Would we consider NVIDIA risky? Based on our definition, we’d look at their long-term performance and their ability to adapt and grow. While their stock has been volatile, the underlying business has shown resilience and innovation, which suggests a lower long-term risk.

Main takeaway

Volatility and risk are not the same, and recognizing their differences can make you a more informed investor. For us, risk is about the potential for long-term loss or severe underperformance, while volatility is about short-term price swings. Many people mistakenly treat them as the same, leading to confusion and potentially poor investment decisions.

By understanding that volatility is a natural part of the market and focusing on managing risk, you can take advantage of market opportunities and plan more effectively for the future. Remember, the goal of investing is not to avoid volatility but to manage risk wisely and stay focused on your long-term financial goals.