If you’re reading this, you probably have some understanding of what volatility means. But that doesn’t mean everyone does. A recent study found many investors misunderstand volatility and how it affects their portfolios.
Volatility Is A Measure Of Risk
Volatility is a measure of risk. It is the standard deviation of a return, which means it measures how far a series of returns deviates from its mean.
A high-volatility stock will have more ups and downs than one with low volatility, but each move will not be as extreme as it would be for the other investment (i.e., if you invested $100 in both stocks and they both returned 10%, then the high-volatility stock would have had bigger gains than losses).
It Isn’t Constant; It Fluctuates Over Time
The first thing to understand about volatility is that it’s not constant. It changes over time, and it can be high or low depending on the market.
High volatility means that your investments are subject to big swings in value–up or down–which means you need to be prepared for those changes and be able to withstand them as an investor.
See It As The Standard Deviation Of A Return
The standard deviation of any investment is a measure of its risk. It tells you how much an investment’s returns vary, on average, from their long-term trend or mean. The higher the standard deviation, the more volatile an asset’s price movements are likely to be; this means that there is more uncertainty about how much money you will make from your investment in any given period (and also more opportunity for large profits).
It Measures Risk And Its Level Will Change Over Time
All investors need to know about volatility is that it measures risk and that its level will change over time.
Volatility measures how much the returns of an investment vary from day-to-day, month-to-month, and year-to-year.
It’s also called standard deviation because it tells us what percentage of our portfolio could be lost during any given period if we invested all our money at once in one stock and held on without rebalancing or adding new funds (more on this later).
Conclusion
What does this all mean? Well, the first thing to remember is that volatility is a measure of risk. It’s not something you should worry about on its own, but rather as part of a larger portfolio.
If you’re not comfortable with volatility in your investments, then you should consider lowering your exposure by purchasing less stock or selling some out-of-the-money puts on ETFs such as SPY (SPDR S&P 500 ETF), which tracks the S&P 500 Index; IWM (iShares Russell 2000 Index Fund), which tracks small cap stocks; and XLF (Financial Select Sector SPDR Fund), which represents banks and insurance companies among others.