“Risk” is the possibility that you will need money but don’t have it, due to a fall in the value of your investment portfolio, OR because your investments are not very liquid.
E.g. – Real estate is not very liquid. Investments in Equity MF/Stocks are Liquid but Fall in Value in Short Term discourages one to Disinvest.
“Volatility” comes into play with all the Liquid Investments which becomes a threat to your Goals in the short term.
E.g.- 2008 Indian Stock Market Fall During Financial Crises, 2011-2012 UPA 2 Policy Paralysis Crises, Feb 2016 Commodity Crash due to China are a few which lead to 20% to 50% Fall in Value of Investments.
Challenges for Young Investors, Middle Aged Executives, or Retired People:
These risks are tough enough for younger investors. But they are even more challenging for those who are within 5 years of retirement or already retired. After all, the next financial shakeup will occur very close to when you likely plan on using the wealth you have been accumulating for decades. So, it’s not the time to take chances when you need Money.
Investors Must Differentiate RISK & Volatility to Ride the Journey of Investing
It helps to separate “Risk” from “Volatility”, Two Different Things. Volatility in investing is often temporary, but Volatility may give you a feeling of RISK your Knowledge of Investing/Investment product is Superficial. When you don’t know yourself well enough as an investor, volatility can get emotional. And once you let Emotions into your Investment, Bigger Issues in your Financial Planning Failure crop Up. That’s not planning!
So, you must find a healthy balance between Risk, Volatility. Volatility is inevitable in your financial life, While the Risk of taking that volatility too lightly is wrong. Throughout Investment Strategy like Asset Allocation Model, Risk Management one can Address Volatility, Liquidity & Perception of Risk towards investments. Unfortunately, many traditional approaches to building an investment portfolio don’t really address this.
Action Plan for Investors
One needs to determine how much loss of value one can take before those emotions start to demonize an otherwise solid approach. This is like a cardiac stress test as preventive medicine against a potential heart attack.
Investors don’t Diversify Financial Instruments as per Exposure to Bonds & Equities which leads to an Understanding Issues with Volatility, Risk & Ultimately Liquidity.