We have spoken in the past about risky portfolios…
But never about specific investments. Are they one in the same or are they a completely different animal?
As investors, we would like to avoid volatile returns at all times and sometimes this means staying away from volatile investments.
This is an open question to all and feel free to comment down below, but here we go.
If an investment is considered volatile it means…
For starters, if you want to make any decent returns on your money you have to be comfortable taking on more risk. The age old saying of the greater the risk the greater the reward is still alive and true today.
The video above speaks about how to avoid volatile investments so that when retirement comes, we can have the biggest nest egg possible. But the reality is if we never took and risk we wouldn’t have a big nest egg, just a small one.
So answer me this? What is a volatile investment? I feel like when people ask if an investment is considered volatile it means that the investment loses money. They don’t ask if it was or is volatile or not, it is all about the end result being losing a decent amount of money is what makes it “volatile”.
An Example of a Volatile Investment?
Let’s go through an example of two investments and we can walk and talk through which of the two are volatile investments if at all.
|Investment 1||$500||+1 share of $SPY||$236.80|
|Investment 2||$250,000||+2,500 shares of $SLV||$40,075|
Which of these two investments are riskier?
In investment 1, we are buying just one share of stock while in investment 2 we are buying $2500 of stock.
Most people would surprisingly say that investment 2 is riskier because of the sheer number of shares purchased. If silver goes down, then the “entire portfolio would go down” type thing.
But the reality is, investment 1 is taking up 50% of the portfolio size while investment 2 is taking up less than 20% of the portfolio. In this scenario, investment 1 would be FAR more volatile than investment 2 because of its enormous size. Size kills and is what causes volatile investments and returns.
If an Investment is Considered Volatile it Means…
Now, remember, it isn’t’ the investment that people associate with volatility, it is the losses they incur. They could have an investment that EVERYONE says is volatile, however, if they make money right away, nobody is going to consider it volatile.
How do we make sure that the losses we potentially have are not volatile besides not investing at all? We make them small 🙂
If an investment is considered volatile it means it is too big. If we have small investment size, it does not matter how bad the losses are because our size is kept in check. If we have 1% of our portfolio allocated to one specific position and it tanks, would we consider those losses volatile? Of course we would not because we have such a small percentage of our overall capital devoted to that one position. We have 99% of the rest of the capital tied up elsewhere. But if we have 50% capital tied up in one position and that tanked, then yes we would consider it volatile because of the size of the loss. Both of these scenarios have nothing to do with the original investment and everything to do with the end result.
Food for Thought on Volatile Investments
Remember, they are only volatile if they are too big. Let’s look at an example.
|Portfolio||Percent Allocated to Each Position||Chances the Portfolio Goes Busto|
|1||20%||1 in 32|
|2||10%||1 in 1,024|
When somebody asks you what makes an investment volatile, you look at them, smile and say, “if an investment is considered volatile it means it is too large”.