What is the Difference Between Risk and Volatility While Opting Investment?
There has been a fair amount of debate regarding the intrinsic difference between risk and volatility as concepts. A senior citizen who has just retired may have always chosen conventional investment avenues like fixed deposits, post office savings schemes and other small savings schemes.
He/she has gone for FDs since he/she does not want to take any risks with money even if the current fixed deposit interest rates are lower than those offered by several other market-linked investments.
On the other hand, the son/daughter of this senior citizen has minutely studied investment avenues and may advise his/her parent to keep a part of his/her retirement funds in equity since the returns may be higher than interest rates on FDs.
This will enable the corpus to grow faster and it may beat inflation. However, the parent will still say that equity is volatile and hence FDs make for better investment options even though FD interest rates may seem lower.
Risk for Investment
Does this situation sound familiar? This is a major debate that has been going on in the present scenario. It is here that risk and volatility deserve to be examined more closely. Risk is basically the chance/possibility of a loss/injury/hazard.
In financial terms, when a person worries about any risk, he/she is worried about the possible loss (permanent) in terms of money. Volatility is just the paradigm of how fast/considerably the price changes for an investment.
Taking this logic into account, aren’t interest-bearing investment avenues including PPFs volatile since their returns change with changes in rates of interest? Have PPF investment rates always remained fixed?
Don’t financial institutions change rates offered on fixed deposits? Equity prices are known for their major fluctuations and this can take place regularly. However, a risk of loss cannot simply be ascertained just because there is fluctuation of prices.
Volatility for Investment
As a result, volatility does not equate to the risk of any losses and simply means the movement in prices. Some investments have higher levels of volatility while some others have lower volatility levels.
In case savings accounts were volatile, people would not want to keep funds to be withdrawn immediately. Volatility really matters whenever there is any immediate need for money since the customer will then have to sell and bear a loss in case of a temporary decline in share prices.
This is why short-term investments are not encouraged in the equity market. The equity market is more volatile in comparison to bank deposits.
However, just because investments are more volatile, it does not mean that they are riskier in the long-term. The potential for risk and volatility in the short-term should be worked out in terms of how it affects the value of investments. This should be the basis for planning all investments according to experts.
Category: Investing
