The terms “risk” and “volatility” are often confused in investing – but it’s vital to understand the difference between the two. While the two terms are interconnected, there are some fundamental differences: understanding these can make a big difference to your portfolio.
What is risk?
The broadest definition of risk, when it comes to investing, is the likelihood of you losing your money, or see lower returns than you may have expected/predicted. There are three different types of risk to bear in mind:
- Inflation risk is when inflation is higher than the return that your investment offers, causing it to devalue and potentially be worth less in the future.
- Liquidity risk is the risk that comes with not being able to access your money immediately should you need it – for example, if you’ve invested in an illiquid asset like property.
- Volatility risk comes when you need to sell your assets at a time when their value is low – or panicking that a price is falling too fast and selling before your asset returns to a peak.
What is volatility?
Volatility is a term that describes how much investment prices go up and down over time. If the price of an investment remains pretty consistent over time, it’s considered to have low volatility. If the price goes up and down a lot – and dramatically – it’s considered to have high volatility.
However, just because an investment is volatile now doesn’t necessarily make it a bad thing. If you’re investing for the longer term, you can keep an eye on the overall trend of your investment to assess whether the price is rising or falling. Some investors also use volatility to their advantage: buying when the price is low, and selling when the price is high.
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