Whenever you invest, there is a trade-off between risk and return, and this is undoubtedly true.
But, when it comes to measuring risk, things are not always what they seem.
The problem arises with the way in which analysts measure this risk.
You see, their favourite measure is “volatility of returns”, with no regard for the direction, up or down, of that volatility. Thus, an investment that goes up by a steady, constant amount will have a lower risk than one which goes up in fits and starts.
So far, so good. However the problem arises when an investment that falls by a steady, constant amount will be rated at the same risk level as the one that rises by a steady, constant amount. Likewise in the case of an investment that falls in fits and starts v’s one that rises in fits and starts.
OK, so this measures volatility. But who in their right mind would regard an investment that is constantly rising, as risky?????? And, the plot thickens when you then bracket this kind of investment with one that is falling, and say they both carry the same risk!!!
The moral of the story is simple:
Yes, in many cases, volatility is a measure of risk – but it is far from complete, and in some cases can give weird answers. Also, there are other risks that volatility does not capture at all. One is longevity risk – i.e. you live too long for the money you have.
By all means consider volatility, but consider other things as well.
