When it comes to investing, volatility isn’t just a buzzword – it’s an inherent and powerful force in capital markets. While many investors fear volatility as a sign of risk or instability, it should instead be embraced as a catalyst for opportunity. Volatility creates moments to adjust portfolios strategically, unlocking value by repositioning into more attractively priced assets and managing risk more effectively. Understanding and appreciating volatility is essential for navigating the ups and downs of investing with confidence and purpose.
What is Volatility and Why Does Volatility Matter?
In simple terms, volatility refers to the degree of variation in the price of a financial asset over time. Higher volatility means prices swing wildly, while lower volatility indicates more stable price movements. Volatility is often viewed negatively, especially during downturns. However, it is an essential feature of markets, and understanding it is crucial for making informed decisions.
While investment returns and risk profiles are directly affected by large price fluctuations, volatility provides investors with an opportunity to rebalance their asset allocations. It allows for reallocating into mispriced assets, harvesting losses, and recalibrating risk. Without an active plan and strategy, investors may fall prey to emotional decision-making, which remains one of the greatest challenges to successful investing.
Measuring Volatility: Tools and Techniques
Volatility reflects the market’s response to new or unexpected information and changes in investor sentiment. It generally stems from market uncertainty, often triggered by news events, economic data, or shifts in investor outlook. There are various ways to measure these market fluctuations, from statistical tools such as standard deviation to market indicators such as the VIX Index (commonly referred to as the “fear index”), which can help measure market movements. [Learn more about how volatility is measured here.]
Below are a few key methods investors use to assess risk and volatility.
- Standard deviation – a core statistical tool that measures how much an asset’s returns deviate from its average over a specified period of time. The higher the deviation, the greater the volatility.
- Beta (β) – gauges an asset’s sensitivity to market movements. A beta above 1 indicates higher volatility than the market; below 1 suggests less volatility. This helps investors understand how assets might respond to broader shifts.
- Implied Volatility – derived from option pricing, reflects the market’s expectations of future volatility. Unlike historical measures, implied volatility is forward-looking and signals potential upcoming swings.
- The CBOE Volatility Index (VIX)¹ – measures expected volatility in S&P 500 index options over the next 30 days. Rising VIX values typically signal increased market uncertainty and investor caution.
Implications for Investors
Volatility has practical implications for investment strategies and portfolio management.
- Risk Assessment: Volatility serves as a proxy for risk, helping investors evaluate their current positioning and adjust for optimal exposure.
- New Opportunities: Market volatility can provide investors with chances to harvest losses, capture value, and reposition into undervalued assets.
- Portfolio Diversification: Understanding an asset’s volatility and its correlations with the rest of the portfolio can assist in building more robust portfolios.
- Performance Evaluation: Monitoring volatility regularly improves alignment with benchmarks and risk targets.
Setting Expectations for the Journey
A clear understanding of risk and volatility is key to setting realistic investment expectations. We work closely with clients to help them understand both potential risks and rewards. For today’s investors, embracing volatility can transform a perceived threat into a strategic advantage.
Because market changes can be unpredictable and difficult to respond to in real time, active management is essential for staying prepared. We actively manage risk to reduce unnecessary fluctuations and improve portfolio efficiency by constantly scouring the market for better value.
Our total portfolio approach to investment management focuses on holistic risk management rather than managing asset categories in isolation. This can help clients navigate varying market conditions while staying aligned with their long-term financial goals, even during turbulent times.
Volatility is not the enemy of long-term success, but a critical component of strategic investing. By acknowledging it, investors can be better prepared to navigate uncertainty with greater clarity and purpose.
¹https://www.cboe.com/tradable_products/vix/