One of the key aspects to become a successful investor is to understand “Volatility and Risk in Equity Investments. While volatility is observed in the bond market, gold market, real estate, or equity market however, the high volatility which is been observed in the equity market is often misunderstood. While uncertainty is the rule of this world, the most common reason for people not investing in equity markets is this uncertainty – the daily fluctuations in the equity markets which are the result of the choices made by the investors as a collective group, which are themselves the result of their collective emotions. This means that, in a way, each investor is responsible for the fluctuations in the market.
But why do the fluctuations in the equity market scare people? The fluctuations in the equity markets create a fear of loss, and because the fear of loss is accompanied with a hope that it will be avoided. It is due to this reason why psychological research shows that the intensity of the fear of going to jail demoralizes more than the amount of sadness one feels when one is actually going to jail because the former is accompanied by the hope that one will not be caught. It is also this logic which is in place when the amount of the feeling of desperation one has when you are headed to a meeting and suffer from a flat car tyre on a deserted road is much lesser than the feeling of helplessness one feels when one leaves for the meeting well in advance but is stuck in a massive traffic jam because the latter is accompanied with the hope that the traffic jam will ease soon.
It is this fear of loss due to the ups and downs in the market that leads investors to stay away from the market. However, it is important to understand that quite similar to the ups and downs on the roller coaster that we hop on for pleasure, the ups, and downs in the market are not dangerous in themselves. Because while investors who have stayed put in the market in the past have gained tremendously in the market, those who have quit prematurely out of the fear of losing have been the ones who have failed to truly gauge volatility and have suffered a permanent loss.
One who is afraid of volatility, for him the temporary loss is converted into a permanent loss. Many investors want to invest in equities only when the volatility reduces. Volatility is omnipresent. It is a normal and necessary piece of investing. It is an integral part of any investing.
There is an old story of “The Saint and the Scorpion” wherein a saint continues to help a scorpion drowning in the river despite the scorpion biting the saint every time he picks it up. The saint remarks about how biting is the inherent nature of the scorpion while helping others is the inherent nature of the saint. In the same vein, it is important to understand that volatility is the inherent nature of the stock market and it is not necessarily bad because volatility leads to uncertainty which helps generate returns for investors to reward them for investing in the company in times of uncertainty. Lower volatility would lead to lower returns because as soon as investors realize the situation of zero volatility, they would participate in equities, leading to a lower movement in the share price.
Those who understand equity always want volatility in the market as it is this volatility that provides returns. If stocks become stable, people will forget the risk and feel safe. Many people invest only in instruments where there is certainty. However, what they fail to understand is that while certain instruments may provide certainty about the rate of return, the fact that return on equities will be uncertain is itself a certainty.
The volatility in the market and the resultant fluctuations in the market are also a result of the way we perceive news and react to it. While it is important to check the news periodically to stay updated, it is equally important to not overreact. While there will always be fluctuations, volatility, and uncertainty in the markets, it is advisable to accept them and ensure that one is well diversified with well-researched proper asset allocation and a relaxed mindset. While no one can gauge the short term trend of the market, one can look at the development parameters of a country to assess the long term investment opportunities on offer. It is important to accept, face, and conquer volatility as it is the primary reason that equities have delivered 14% returns over the past 20 years, irrespective of the fact that most investors earn below-average returns. The reason for this paradox that equities deliver the highest returns while investors earn some of the lowest returns is anyone’s guess.