Volatility is the price you pay for long term gains

The cost of higher returns

One advantage stock investors have over fixed income investors is higher returns over a long period of time.

But this benefit comes at a price. The trade-off for better returns is more volatility or the tendency to change rapidly and unpredictably.

Volatility is often seen in a negative way. But objectively it should be neutral to a portfolio’s expected returns.

You could lose 20% of your money, but you could just as easily make a 20% gain. Introducing more volatility doesn’t change the expected return of an investment per se.

In fact, Warren Buffett has dismissed the idea that volatility represents risk.

“The true investor welcomes volatility. A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.” (Warren Buffett – 1993)

He also argued that holding currency-denominated assets such as cash or Treasury bonds, which have their value eroded by inflation over time, is actually riskier than owning stocks for the long term.

So the best way to look at volatility is to accept that it’s part of the investing game. And like any game you have ups and downs. 🙂 The real risk is not knowing what you’re investing in.

The volatility in the stock market today is necessary payment for continued, long term growth. And if you understand this then your portfolio of high quality assets should do just fine over time. 🙂

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