Risk vs. Volatility: Understanding the Difference Can Save Your Retirement
- Jonathan Harner, CFP®
- Apr 17
- 4 min read
If you have ever felt your stomach drop after checking your investments during a market downturn you’re not alone. But here's the thing most investors miss: that sinking feeling in your stock isn’t due to risk, it's because of volatility.
Let me quickly back up and provide some context. Two of our core investment principles at
Wichita Wealth are: Diversification and Volatility is Expected.
I often see investors confuse risk and volatility, but understanding the difference between the two has a dramatic impact on your financial success and peace of mind in retirement. So, what's the difference? Why does it matter to your financial future? And what do our investing principles have to do with anything? Let's talk about it!
What is Risk?
Risk is primarily the possibility of permanent loss. For diversified investors, this has historically never occurred without poor investor behavior.
I think one of the best examples of risk is Enron. In the early 2000s, Enron was labeled a "sure bet," an investment that couldn’t fail, until billions of dollars disappeared in a matter of weeks due to fraud. Investors who were heavily concentrated in Enron stock experienced catastrophic permanent losses.
This is why we diversify. To ensure a single bad actor or unexpected event doesn't derail your entire retirement strategy. This also explains why we don't chase trends, no matter how attractive a single company (like any tech giant) might look at the moment.
What is Volatility?
Volatility is the market’s natural fluctuations, the ups and downs in response to the latest news, geopolitical events, or economic reports. It's short-term, temporary, and expected (although it's expected we don't know when or why it will occur, only that will at some point).
Interesting note: Since 1990, the S&P 500 has experienced an average intra-year drawdown of about 14%. However, the average annual return over that same period was around 10%. This means that despite regular short-term volatility, the market usually ends positive.
Bear markets, periods when the market drops 20% or more, historically occur about once every five years. Yet, despite bear markets, the S&P 500 has grown nearly 100-fold over the past 65 years (excluding dividends).
So, volatility is to be expected. And while volatility is unsettling it is fundamentally different from actual risk, which is permanent loss. This is assuming you have a properly constructed portfolio.
The Power of Diversification
Because we can't predict the future, broad diversification is our strongest protection against real risk... permanent loss.
We diversify by owning thousands of stocks and tens of thousands of bonds across sectors, industries, and geographies protects you from unexpected events, fraud, or single company collapses (like Enron).
Diversification isn't about maximizing short-term returns; it's about ensuring you stay in the game long enough to achieve your long-term goals.
The Myth of Market Timing
Even though we know we can’t know the future, there is a perennial temptation to try to predict or time market highs and lows. This rarely works. Instead, staying consistently invested is proven to be far more effective over the long run.
Research by Vanguard highlights a critical truth: staying invested during volatility is essential.
Between 1988 and 2023, an investment of $100,000 in the S&P 500 would have grown to roughly $4 million. However, missing just the 10 best market days during those 35 years, returns dropped by 59%, reducing the investment to just $1.7 million. Missing the 20 best days resulted in a 74% drop, shrinking the investment to just $1 million.
Staying invested, even when markets are turbulent and uncertain, has a significant impact on your long-term financial success. You don’t have to outsmart volatility; you just need to outlast it.
Big Mistake Insurance is Your Financial Advisor
A real financial advisor will not promise or even try to beat the S&P 500. So, why hire them? Because a real advisor offers something far more valuable: "Big Mistake Insurance." (as a side note a "financial advisor" who promises to beat the market is called a hedge fund manager)
This "insurance" protects you from making costly decisions during market downturns, like selling out due to panic. Missing even a few of the best days in the market can significantly reduce your long-term returns. Working with an advisor so you have "Big Mistake Insurance" is like wearing a seatbelt. You don’t need it every day, but when the unexpected happens, it saves you from irreversible portfolio damage.
We are not trying to hit homeruns; we are trying to prevent catastrophic mistakes. Hitting homeruns often enough to make the big swing worth it is nigh impossible. Preventing catastrophic mistakes is relatively simple, it’s just not easy. This is why many investors are unable to avoid these mistakes. As Charlie Munger said, “Avoiding Stupidity is Easier than Seeking Brilliance. The path to success often comes through avoiding major mistakes rather than pursuing brilliant moves.”
Portfolio Management: Beyond Beating the Market
There are a number of ways to increase your long-term wealth that do not involve trying to beat the market. Good portfolio management has little to do with picking the right individual stocks.
Rather it involves:
Investment Allocation: Selecting the right investments.
Investment Location: Holding the right investments in the right accounts.
Strategic Diversification: Balancing across company sizes, sectors, and global markets.
War Chest: Maintaining appropriate amounts of stocks, bonds, and cash.
Tax Harvesting: Minimizing tax liabilities strategically by harvesting gains or losses.
Rebalancing: Preventing your portfolio from becoming too conservative or aggressive over time.
Understanding the critical difference between risk and volatility can change your investing perspective, and ultimately protect your retirement dreams. Diversification shields you from genuine risk, while embracing volatility and staying invested through ups and downs positions you for long-term success.
Stop worrying about risk and volatility, instead enjoy a clear path to retirement success. Schedule a call today and let's have a no-pressure conversation about how Wichita Wealth can help you achieve your financial goals with confidence.
Get started with a phone call today.
