Volatility is defined as “a statistical measure of the dispersion of returns for a given security or market index”. Simply stated, it measures outcomes and where they land, compared to other outcomes. In most cases, the higher the volatility, the riskier the security. Volatility can be measured in a couple of ways, through either standard deviation or variance.
Volatility often refers to the amount of uncertainty or risk related to the size of changes in a security’s value. A higher volatility means that a security’s value can potentially be spread out over a larger range. This means that the price of the security can change dramatically over a short time period. A lower volatility means that a securities value does not fluctuate as dramatically and tends to be steadier. In the securities markets, volatility is often associated with big swings in either direction. When the stock market rises or falls more than one percent over a sustained period, that is defined as a volatile market.
When it comes to looking at a particular stock, we can use Beta to help measure the volatility. Beta approximates the overall volatility of that stock's return, against the return of a relevant benchmark. Quite often, people will look at the Beta of a company versus the Beta of the S&P 500, which is always 1.0. This shows that if you have a company stock that has a beta of 1.1, then every time the market goes up by 1%, that company stock should theoretically go up by 1.1%. If the market goes down by 1%, that stock should go down by 1.1%.
Let us illustrate just to build on this point. Suppose an investor is building a retirement portfolio as they are retiring within the next few years and are looking at stocks to invest in with low volatility. Let’s say, hypothetically and for example purposes only, that the two companies they are looking at are Microsoft (Beta of 0.78) and Shopify (Beta of 1.45). By comparing the Beta’s alone, we can assume that Shopify is significantly more volatile than Microsoft. If the market was to go up 100%, in theory, Microsoft would go up 78% and Shopify, would go up 145%. In this example, based on this person looking at retirement, building a retirement portfolio, they may actually choose Microsoft because it has less price volatility compared to Shopify.
So, how do you handle your investments if you're worried about market volatility? Start by reshaping the thoughts you have around investing. Focus on having a highly diversified portfolio, with a proper asset allocation that follows a well-developed plan. This will always provide you with the best foundation for your investments and your peace of mind.
Stay happy, stay safe, stay well!
The CM Group