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Risk and volatility are not the same thing [video]

Even financial professionals make this mistake...

    Financial advisers and financial planners will use words like risk and volatility...

    And assume that everybody knows what they mean...

    Financial writer and podcaster, Carl Richards, explains why the two often get confused...

    RP: Many people, including financial professionals, use the terms risk and volatility as if they were interchangeable. In fact, two very different things. Here’s the financial writer and podcaster Carl Richards.

    CR: Often, we use words like risk and volatility and we assume, the industry, even really good financial advisers and financial planners will use words like risk and volatility and assume that everybody knows what it means. I know I wouldn’t if I was not in this industry, there is no way. If I took a statistics class in college, I wanted to forget it as soon as possible. Most of us don’t know what that means.

    RP: Risk specifically refers to a permanent loss of capital. Market volatility, on the other hand, is by its nature short term, and a relatively common occurrence. As long as you stay disciplined during periods of volatility, they shouldn’t pose a long-term risk at all.

    CR: You view volatility as really scary and risky in the short term but not risky in the long-term. And so, volatility is really underneath, just a measurement of standard deviation. What that means is: ‘How much does something wiggle?’ That’s all it means. Stocks wiggle more than bonds, bonds wiggle more than cash. You’ve just got to decide if you can handle that. Now, there’s a whole bunch of tricks and techniques you can do to ignore it. Right, if you’re not paying attention to it, you don’t have to deal with it. So, that may be a hint.

    RP: The distinction between risk and volatility is a very important concept for investors to understand. If you’re in any doubt about it, you should see a financial adviser.

    CR: As a client of an adviser, the one thing I think you should feel absolutely sure that you can do, is to say: ‘Hold on, could you back-up and explain that?’ Just ask clarifying questions. Any good adviser will appreciate it, and if they don’t appreciate it - find a different one.

    RP: So, don’t confuse risk with volatility. And never be afraid of asking your adviser to clarify anything you don’t understand.

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