Volatile finances: unpacking investment misconceptions

In this piece, I'd like to unpack a couple of common financial misconceptions.

Firstly, the difference between an investor return and volatility is commonly misunderstood.

In finance, average returns and volatility are different things and affect investors differently. However, measures of volatility steal the limelight, often as the main focus of financial reporting.

To quote Investopedia, a return is "the gain or loss of a security in a particular period. The return consists of the income and the capital gains relative on an investment." A return is what you can realistically expect from a set of given assets over a period of time.

Volatility is how that return is likely to oscillate over short time periods. Investopedia states that "volatility is a statistical measure of the dispersion of returns for a given security or market index. Volatility is measured by using the standard deviation or variance between returns from that same security or market index."

Volatility means a security or market index can swing up or down on an hourly or daily basis, whereas a return is what you can reasonably expect over a given period.

Financial markets have been more volatile over the past year and this is likely to continue. But how it affects investors is perhaps not how you might expect.

This leads me to the second misconception I'd like to address: that a volatile financial market is bad for investors.

Every day, we hear news reports of stock market swings. I see firsthand how these swings affect many people's perception of financial market investment opportunities. They view these investments as risky. The constant, daily news commentary on the share market is about its volatility.

At the same time, the property industry is vocal about profitable returns, but I view a lot of this commentary as misleading. More often than not, these commentators are quoting gross returns not net returns and frequently neglect to provide a credible index or detail of what's included in the cost base, such as capital gains tax or costs associated with acquiring, holding and disposing of the property.

The key takeaway here is that financial market volatility should not worry you if you are looking to build medium - to long-term growth. The stock market is like a constant live auction, with assets marketable (at the push of a button) at any given time.

It's more important to keep in mind that volatility's effect on someone who is trying to maintain an established investment base is fundamentally different to its effect on a high-income earner without established capital.

The current financial market climate tilts the balance in favour of high-income earners who don't yet have a large capital base, rather than those who have already built their investment base.

• If you have a lot of capital and not much income, then protecting your capital base is important and more challenging under these conditions.
• If, on the other hand, you have a high income and not a lot in assets, it's a wonderful opportunity to build wealth.

When it comes to financial planning, I recommend the following to clients who wish to capitalise on their situation and build wealth:

• Now is a good time to sensibly and methodically consider available investment opportunities.
• Develop an investment plan informed by accurate and unbiased analysis, with a clear understanding of investments' likely returns (versus volatility) over an extended period of time.
• Be selective when seeking advice; consider the credibility and integrity of the information source and take care not to confuse expertise with share of voice.

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