One of the main concerns for any type of investing is market volatility. Volatility measures the degree to which prices change over time. Another way to think of volatility is in terms of price swings. The greater and more frequently an investment’s price swings, the higher its volatility. Investments with high volatility have a high degree of risk because their prices are unstable.
It is important to note that short-term volatility is not necessarily indicative of a long-term trend. A security can be highly volatile on a daily basis but show long-term patterns of growth or stability. Some investments may maintain purchasing power over time, but can fluctuate wildly in the short term. For example, look at the chart below. There are some pretty nasty downtrends in there. And if we zoomed in further, we’d see some awful individual days and weeks. But what direction is the overall trend?
The advantage of long-term investing is found in the relationship between volatility and time. Investments held for longer periods tend to exhibit lower volatility than those held for shorter periods. The longer you invest, the more likely you will be able to weather low market periods. Assets with higher short-term volatility risk (such as stocks) tend to have higher returns over the long term than less volatile assets such as money markets.
Two topics that you will hear us talk a lot about at SWM, whether it’s in the content we put out or just chit-chatting around the office are 1.) behavioral finance and 2.) education. We believe that human emotion and (ir)rational decision making play a large part in longer-term market trends. Regarding education, while we constantly trying to learn ourselves and expand our own knowledge of personal finance and investing, we make it a top priority to ensure that our clients stay educated as well.
What is behavioral finance?
Behavioral finance, a sub-field of behavioral economics, proposes psychology-based theories to explain stock market anomalies, such as severe rises or falls in stock price. The purpose is to identify and understand why people make certain financial choices. Within behavioral finance, it is assumed the information structure and the characteristics of market participants systematically influence individuals’ investment decisions as well as market outcomes. It focuses on the fact that investors are not always rational, have limits to their self-control, and are influenced by their own biases.
“What are you talking about?”
Over our careers, we have discovered that while some clients may not be as educated on the market as others, they also don’t want to be talked to like they’re a child. In fact, it’s usually quite the opposite. They would rather be educated on topics, so that they can understand what their advisor is actually talking about. Financial lingo isn’t necessarily scary if you have a solid base of knowledge around it. That’s where we come in! As much as we want to help your financial nest egg grow, we also want you to feel for comfortable discussing financial topics, whether it’s with us or with others.