What is Volatility?

 What is Volatility?

Preamble

Things must be made as simple as possible, but never simpler. - Albert Einstein

I often find myself puzzled and discouraged when listening to professionals speak in a subject or field I have limited knowledge in. I very much wish to pick up what points they are expounding upon, but the absence of knowledge in their common language leads me to miss the significant points. That common language is jargon. 

Jargon is defined as a special language belonging solely to a group, often a profession. Jargon language, by its own interpretation, eliminates the understanding of people outside the profession. Jargon has other negative consequences as well. 

If you use jargon, it can make it challenging for someone to not question you on an idea you are expounding upon. Why? Because the individual on the receiving side of the exchange does not wish to propose a naïve question. So, they shake their head up and down in complete understanding, but leave the discussion not knowing any of the points you have expressed. Would you recognize that as an effective discussion? 

That thought has convicted me to take “common financial jargon” and define it terms you can pick up or figure out if you find yourself outside the field of financial planning or investing. It will prepare you with the understanding the next moment you discover yourself in a dialogue about this space.

My intention is to not be difficult on professionals. They spend 90% of their working life either speaking to other experts or pondering complex matters. It is not jargon in their language because they practice it every day. Jargon is a by product. 

Preamble over. 

 

THE WORD CHOSEN FOR TODAY’S DISCUSSION IS VOLATILITY.

 

What is Volatility?

Volatility defined is the ability to change immediately. Ability is the key word in the definition. Something being volatile does not mean it will change, it means it can change quickly. 

Volatility is a descriptive term to illustrate the risk of an investment by how the price fluctuates up and down. An illustration describing is below. 

 

Price

The key word used for a measure of volatility is price. Price is problematic to measure against because it does not account for value. If tomorrow you are at the supermarket and recognize the price of a box of cereal was 4 times the initial cost as the day before, would you consider that box more valuable because of the change in price?

As investors, we concentrate on the long term value of investments and not the short term price. Which leads to the next question.


Is Volatility Good or Bad?

It is neither. It is a descriptive term much like the color green. 

Volatility interpreted in the investing space as something to avoid with a limited explanation as to why.  

Volatility is not good or bad, but the lack of knowledge of volatility is detrimental. If you understand volatility, you may consider what is taking place when the price of your investments fluctuates up and down. 

Now with the knowledge of volatility, you may avoid investments that historically have a considerable amount of volatility. You may prefer given your tolerance for risk, to have an investment portfolio of lower volatility. However, it is essential to recognize that we do not know the future, so every investment has a volatility we can not entirely grasp. In defense of the professionals who assign volatility to certain investments, most try to give their level best to anticipate a range of outcomes. 

It is right and good to use this range of outcomes with investment assumptions. It at least gets us in the ball park. However, we should watch out for a false sense of precision when depicting investment outcomes. That is why we have step 4 in our financial planning process. It states:

When a flight leaves from LA to NY, the pilots know they will make course corrections because some variables of the flight are unknown until they come upon them.

Some goals discussed during the financial planning process can be described as "best guesses". There is no way of knowing today what your utility bill will be 32 years from now. It is not the guess that matters. It is the ongoing process of guessing that matters. We will meet periodically to take in the new info that has been presented to us and update our solutions.  Our solution document is a living document. Not a one time event. 

If you would like to learn of the other steps in our financial planning process. You can do so by clicking here.

I hope that the use and interpretation of volatility is a little clearer now. 

If there are alternative concepts or words in the financial planning space, you would like expressed in this fashion, please send recommendations to matthew@visionfinancialconsulting.com. All recommendations are welcome. 

Also, using that email address, please share any remarks or questions you have on this piece. I am grateful for your feedback.

 

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