Problem Statement

Volatility & Risk

Why Volatility Can Be Bad for Long-Term Returns

For investors, it's difficult to read the news these days without hearing about instability. 2020 has been a wild ride for a variety of reasons, not the least of which has been the stock market's dizzying fluctuations. But what exactly do we mean by volatility, and why should long-term investors avoid it?

Many investors associate "volatility" with "risk." Risk, in this view, is a necessary evil in order to reap the benefits of higher returns. In fact, volatility is only one of many risks that investors face. It is also not essential to have a volatile portfolio in order to earn a good return. Instead, by following a few simple rules, smart investors can reap the benefits of high returns while greatly reducing their risk exposure.

• For long-term investors, volatility can destroy wealth a couple of ways. First, volatility creates fear and uncertainty, which can lead to bad investment decisions. While investors know in theory that they should “buy low, sell high,” in periods of extreme volatility it is often the reverse. Too many investors see a big drop in the value of their portfolio and sell to avoid further losses. Panic selling like this is a mistake because it locks in your losses for the long term. Volatility can also make investors fearful about investing more money in the market, meaning they miss out on good trading days and the benefits of long-term compounding