CommentaryFebruary 2019 Commentary

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Do You Know the Difference Between Volatility and Risk?

What is the difference between volatility and risk?  Volatility is the weather outside and risk determines how you are affected by it.

When people tell us that they have a high risk tolerance or a low risk tolerance we often ask them, “How do you define that?”  Frequently, they say they can handle the ups and down swings of the market just fine without worrying.  2008 was a big awakening for many of these people.

We also hear, “I don’t want much risk in my portfolio”.  Again, we ask how people define risk.  “I don’t want to lose money.”  Ok, we don’t either, ideally.  But this strategy doesn’t give us much chance to do anything other than sit still and hope we don’t get hit by an asteroid.

So, let’s use the weather metaphor to break this down.  It’s cold, and an ice storm is brewing.  You don’t want to go hungry.  What do you do?  If you are like many practical people in Kansas City, you have a car with a full gas tank, food in the fridge, and probably some routine tools in your house like a shovel, candles, flashlights and some sort of ice melt.  You probably do not hear that there is an ice storm coming and put your house on the market and take the first offer to get out of town before the storm comes.  You simply prepare for the storm, stay in your home, close to friends and/or family, and make it through.

Now it’s summer.  Oh, the sky is bright, and the sun is warm on your face.  But how long can this last?  Winter always comes.  Should you sell your house now?  Move to another state where it’s always sunny?  Florida is nice, but then you have to deal with hurricanes.  California is nice, but they have fires.  Minnesota- well heck, that’s colder than Kansas City.  Turns out there is no place to go that has perfect weather all the time.

In other words, wherever you live, there is weather risk.  Likewise, wherever you invest, there is investment risk.  The key is how set you are to handle that risk.  With the weather, you prepare with  how you dress, travel, and plan your day.  The same should be true about investment planning.

Volatility in and of itself isn’t bad- in our opinion it actually helps people who understand it make more over time than those who don’t.  What needs to be considered is what risk management tools you put in place.  These are tools like insurance and emergency funds, your standard of living compared to your income, and the liquidity of your assets as a whole.  Someone with no emergency fund, no insurance, and no job should have low exposure to volatility because they have nothing to protect them against the chance of losing money.  Someone with a deep cash reserve, plenty of insurance, and a good income stream compared to their expenses can expose themselves to more volatility to benefit from the upside potential- that warm sun on their face because they made it through the winter just fine.

There are four seasons in a year, just as there are regular market cycles.  It’s the way of the world.  Life has volatility, but you can handle it by thinking about the risk associated with each choice you make and how to mitigate that risk as much as possible.  Then just enjoy the ride.

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The Planned Approach, Inc.

420 W. 98th Street
Kansas City, MO 64114
(816) 941-0098

Our Important Disclosures

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The Planned Approach, Inc.

420 W. 98th Street
Kansas City, MO 64114
(816) 941-0098

Our Important Disclosures

Insights for Your Life Stage

The Planned Approach, Inc. is an Investment Advisor registered with the Securities and Exchange Commission. No client or prospective client should assume that any information presented or made available on or through this website, is a receipt of, or a substitute for personalized financial planning consulting advice. Financial planning consulting advice can only be rendered after the following conditions are met: 1. Delivery of our Form ADV Part 2A and 2B to you; 2. Execution of an Investment Advisory and/or Financial Planning Engagement Letter between us. You may obtain a copy of our ADV Part 2A Disclosure Brochure containing similar information by sending a written request to The Planned Approach, Inc., 420 W. 98th Street, Kansas City, MO 64114. Additionally, please note that hyperlinks included throughout this site are provided as a matter of convenience and we disclaim any and all responsibility for information, services or products found on websites linked hereto. Please contact the firm for further information. The Planned Approach, Inc. is not engaged in the practice of law and does not provide legal advice. Always consult with an attorney regarding your specific legal situation. The Planned Approach, Inc. is not engaged in the practice of tax consulting.  Always consult with your tax advisor regarding your specific tax situation.