Investing 101: What is volatility?



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What is volatility?

One of the most frequently used terms in Generate newsletters and the financial press in recent months has been ‘volatility’. We frequently used it to describe how financial markets have performed and how they are likely to track in the near term.

To understand volatility in a financial markets context it is useful to first review more common usages and then draw parallels. Three frequent usages of volatility:

  • People: a person that is volatile displays rapid and sometimes unpredictable changes of emotion.
  • Chemistry: a chemical that is volatile has a higher propensity to change state.
  • Statistics: volatility is a statistical measure of dispersion around the average.

These examples show that in-essence volatility typically describes changeability and unpredictability. This is also how it is often used for financial markets: volatility is typically used to describe the stability and predictability of returns from an asset class or a particular investment.

All things being equal - investments that have unstable and unpredictable returns have a higher risk than those that provide stable and predictable returns. As a result, an investment’s risk is often measured using the statistical measure of volatility.

Market volatility is normal

It’s important to remember that market volatility is normal. Markets can, and do, go up and down from month to month, and year to year. While a volatile market may leave you feeling uneasy or concerned, it’s usually not worth worrying about as KiwiSaver is a long-term investment. 

Most of us won’t touch our KiwiSaver balance until we are 65 years old, and while we know it can be hard to see your balance go down, history shows that sticking with your plan and staying invested through the ups and downs delivers a better outcome at retirement.

What should I do when the markets are volatile?

The most important thing you can do is stay calm and stick to your plan you had before the volatile period. If you were in a Growth Fund before the markets shifted, it’s likely this is still a good option for you; likewise, if you were in a Conservative Fund before the markets shifted, staying in a Conservative Fund, is probably the right thing for you.

Should I switch funds if the markets are volatile?

We generally don’t recommend this. A volatile market creates both opportunities and risks. For example, when KiwiSaver members move from Growth to Conservative funds during times of market volatility, they can miss a larger rebound in the growth funds, effectively locking in their losses. We saw this when markets went down in 2020 as a result of the initial Covid-19 outbreak, and Kiwis who switched out of their growth fund missed out on the rebounding market in the following months.

Whereas, sticking with your investment strategy through the lows and riding out the volatility, gives you the opportunity to buy units in your fund at a lower price - think of it like buying an item on sale.

If you have any questions, feel free to get in touch with one of our KiwiSaver experts on: 0800 855 322.