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The Difference Between Volatility and Risk

Market Crashing

With today’s market volatility, investors are anxious and stressed. As global stock markets continue to yo-yo, day traders seem to be the only ones who are happy.  It’s important to understand the difference between volatility and risk.  

Risk involves insecure, questionable investments, and putting your money in danger.  Volatility, on the other hand, refers more to the short-term instability of a stock or product due to frenzied markets.  When markets are down, a company that provides a useful, durable product may be affected.  When the market calms however, the company’s stock price will rise again.  Just look back to 2008 with a 40% free fall in values from May until March 2009, only to recover most of that back within 24 months.  There is still a place for value investing, called the “coffee can approach” finding and buying and then holding something stable.

Today’s global markets though volatile, are in good shape and doing exactly what markets do.  If examined closely, there are many great investment opportunities out there.  Of course depending on which life stage you're at, volatility can be your best friend or your worst nightmare.  Someone retiring now in a down market and taking income can have their retirement nest egg decimated in the process, with little chance of recovery.

It's human nature to worry about all the current bad press of the markets but don't stampede to the sidelines with your cash.  Two practices that will help protect your portfolios are to educate yourself and learn to be cautious.  Educate yourself about finding high quality investments and companies, while sticking to investments best suited to your goals and risk tolerance.

If a company sells good products, has a solid history of performance and is likely be around over the next five years, then they're worth a look.  Consider resilient businesses such as farming in emerging markets and funeral companies in economies with aging populations.  One rule of investing is based on the number 20, if the price to earnings (PE) ratio and the current inflation rate adds up to 20 or less, is probably a good buy.  Most people only want to invest into companies once they’ve seen great performance over a few years, when in reality they would have been much further ahead buying earlier to take full advantage of the growth of that investment.

Investors who hide money away or are constantly revising portfolios cost themselves money and in the end, usually create a large gap between their portfolio return and average stock market returns.

There’s no magic way to avoid low returns, so don’t try to beat the market, be the next Warren Buffett or pick the next hot stock.  Look for tangible, long-term opportunities and stick with them.  Case in point; “The recent Facebook IPO” Greed caused its downfall, as investors thought they had found the hottest stock rather than doing some research before investing.  In reality, the company is facing revenue issues and was significantly overvalued by all the hype.  For most of us, buying a stock so you can turn it over for a quick profit is very risky.

Most importantly, don’t be discouraged by market headlines.  The market has much to offer investors willing to do a little extra homework.  Don’t buy the flavor of the month being pushed to enhance someone’s commission.  Satisfy yourself with some research or get professional advice before buying in.

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