Life is full of ups and downs; yet we do not call life risky. Life is simply unpredictable and therefore it’s volatile in nature. Inspite of this volatility we don’t stop living because we know that we’ll sail through as the hiccups are temporary.
Risk and Volatility
Let’s try to understand volatility and risk from investments point of view. How many times have you seen a graph of your any of your mutual funds like this the one show below? May be a lot of times or probably every time when your financial advisor advises you to invest in any equity mutual fund (specially to see its performance over the years :))
These ups and downs that you see in the graph are due to the volatile nature of the equities! Let me take you through what does volatility and risk means in investments-:
Risk refers to the possibility of a loss of money whereas Volatility refers to the rapid or significant change in the price from time to time. The significant change can be a dip or can even be a high.
Thus, from the above definition it can be established that being volatile does not mean being risky. To understand it further, let’s look at the conversation of two friends who are discussing mutual fund investments-:
Ram – The New Investor & Shyam – The Expert
Ram: Isn’t mutual fund a risky investment, Shyam?
Shyam: Why Ram? What made you say that?
Ram: I’ve invested in mutual funds. Last week when I checked, my portfolio was positive by Rs. 100,000 but earlier in the day I found it negative by Rs. 80,000.
Shyam: Oh, alright. I understand. Ram, mutual funds are volatile investments.
Ram: Risky? Right?
Shyam: No Ram, it’s volatile not risky.
Ram: But what’s the difference?
Shyam: Let me explain. A friend of mine invested Rs. 100,000 in a popular scheme of a mutual fund in January 2008; the value of it in March 2009 was Rs. 45,479. That is -54.5% down!
Ram: See, this is exactly what I’ve been telling you!
Shyam: Alright! But before you jump into conclusions, guess what was the value of his investment in November 2010.
Ram: Rs. 70.000? Or, may be Rs. 80,000?
Shyam: No, you are wrong. It was Rs. 136, 687/- (200% up from March 2009)
Ram: Oh My God! Really?
Shyam: Yes, and not only that, the value in January 2015 exceeded to Rs. 212,855. That is 55.7% up from November 2010
Shyam: Not okay, at least not yet. Again in February 2016, it plunged into Rs. 156,398, that is -26.5% down from January 2015
Ram: Oh, again, gone down?
Shyam: And on 18th May 2018, the value reached Rs. 252,049.
Ram: That is really volatile as the prices are changing every now and then!
Shyam: Exactly. But at the end of all this volatile ride, from Jan 2008 to May 2018, Rs. 100000/- has grown to Rs. 252049 (152.05%)
Ram: Yeah, right. Now I know the difference, Shyam. Mutual funds are not risky, but volatile.
Shyam: Ha ha ha… Glad that you understood the matter. Remember, give your investment the time it needs to grow (atleast 5 years when it comes to equity investments). Don’t jump into conclusions and don’t look out for easy, 1 – 2 years return!
Ram: Yeah, you’re right. Thanks, Shyam. Looking to catch up with you often on matters of finance.
Shyam: You’re always welcome, Ram.
Well, we don’t think like this especially when it comes to investments. For us there’s nothing as volatility in matters of investments even if one can prove it through valid arguments. Its only when we experience it. Thus, the next time you see a dip in your mutual fund investments; don’t believe it to be risky as the dip may be temporary.
Had Shyam’s friend discontinued the scheme the very first time his money went down, he would’ve lost it all. And he would have remained a strong critic of mutual funds investments.
Don’t mistake volatility to be risky else you’ll never make money that you see others making!