One of the more commonly misunderstood concepts in investing is the difference between risk and volatility. Many investors assume that a portfolio’s ups and downs define how risky it is, but that is not necessarily true. Understanding the difference between risk and volatility can help long-term investors maintain perspective, stay disciplined through market cycles, and avoid making emotionally driven decisions that can be compromising to wealth building.
Volatility measures the magnitude of how much an investment’s value fluctuates over a given period. We define risk as the potential for a permanent loss of capital or failing to achieve your long-term financial goals.
Our brains are wired to interpret loss as danger, even if it is only a temporary loss “on paper”. Thus, we understand that for most, watching the value of an investment drop tends to trigger a powerful emotional response. The media also tends to do a good job at amplifying this perception, with headlines often framing short-term market dips as “risky” events.
Volatility is Temporary
High volatility indicates larger, more frequent price swings, while low volatility suggests more stable and gradual price movements.
Volatility to the downside is a reflection of market uncertainty and the market’s “mood”, which can range from fearful to euphoric. That said, volatility can make the stock market feel unpredictable for many investors. Over short periods of time, it indeed is. Prices can swing, headlines can turn negative, and investors begin to question their strategies.
While this can be unsettling, long-term investors must recognize that volatility is temporary and that it has historically paid to stay the course.
Risk: The Potential for Permanent Loss of Capital
Investment risk is not about short-term price swings. Rather, it is potential for a permanent loss of capital or falling short of your financial goals. For example:
A company going bankrupt is a risk of total loss.
Failing to outpace inflation over time creates risk of outliving your wealth.
Panic selling at the bottom of a downturn and missing the recovery results in permanent loss of capital and results in risk of outliving your wealth.
Volatility and risk can be related, yet volatility alone doesn’t cause losses. If an investor has a well-constructed portfolio of prudent investments, it is the investors’ reaction to volatility that most often causes permanent losses.
Volatility Is the Price of Admission for Long-Term Growth
While the S&P 500 has had single-year losses exceeding 30%, it has never produced a negative return over any rolling 20-year period in modern history[1]. In other words, short-term volatility is the emotional cost investors pay for long-term growth. If markets were perfectly stable, they wouldn’t offer higher return potential than cash or bonds.
Additionally, from 1985 through 2024, the S&P 500 produced an annualized return of 11.68%[1]. When digesting that statistic, a natural inference one may make is that the index delivered a relatively consistent annual return of around 11% -12% over the 40-year period. However, there were only three years over this period that the index returned between 9% and 12%. Similarly, there were five instances where the index lost greater than 9% in a year.
Over the long run, volatility tends to smooth out, often rewarding investors that are patient.
Managing Volatility Without Losing Sleep
Volatility is an inevitable part of investing, but it does not have to derail your plan and is much easier to tolerate when you expect it.
Here are tips on how to stay steady when markets are not:
1) Focus on Time Horizon, Not Headlines
If your goals are years or decades away, daily market noise shouldn’t dictate your strategy. Volatility only matters if you have a very short time horizon and liquidity needs. If you do have a short time horizon, then the stock market may not be the most prudent way to invest the money you know you will need in the near-term.
2) Keep a Cash Reserve
Cash can provide stability and peace of mind during downturns. It gives you flexibility to cover short-term needs without touching long-term investments.
3) Reframe Market Swings as Opportunity
When volatility rises, quality investments often go “on sale.” Staying disciplined allows you or your advisor to take advantage of those moments rather than fear them.
The healthiest way to view volatility is as a feature of investing, not a flaw. It is an opportunity for those who can navigate it and what allows long-term investors to earn higher returns than those who keep their money in cash.
Final Thoughts
Volatility can understandably make investors nervous, but it does not have to. It is the market’s way of reminding us that growth does not come in a straight line. Risk, on the other hand, is something deeper—the danger of permanent loss of capital or failing to meet your financial goals.
By understanding this difference, investors can avoid the trap of reacting emotionally to every market swing and instead stay focused on the bigger picture, following their plan for long-term wealth creation.
A well-built financial plan doesn’t aim to eliminate volatility. It is designed to help you endure it by aligning your goals, time horizon, and comfort level. In the end, success in investing is not about avoiding turbulence. It is about learning how to navigate through it with confidence and discipline.
Footnotes
[1] Source: NYU Stern: Historical Returns on Stocks, Bonds and Bills: 1928-2024.
Disclosure
RISE Investment Management, LLC ("RISE" or "RISE Investments") is an investment adviser registered under the Investment Advisers Act of 1940. Registration of an investment adviser does not imply any level of skill or training. This publication is solely for informational purposes and past performance is not indicative of future results. Any description of products, services, and performance results of RISE contained in this publication are not an offering or a solicitation of any kind. No advice may be rendered by RISE Investments unless a client service agreement is in place. Advisory services are only offered to clients or prospective clients where RISE Investments and its representatives are properly licensed or exempt from licensure. All of the information in this publication is believed to be accurate and correct as the date set forth. RISE does not have or accept responsibility or an obligation to update such information. This article is for education purposes and should not be treated as tax or legal advice. This article is not a substitute for legal or tax advice from your professional legal or tax advisor.