Why jumpiness matters – ‘the reaction to risk’

Published on March 13, 2020 by Dan Haylett Category: From our team & Investing

The most prevalent question in the uncertain times we are facing is:

‘How do I emotionally handle the volatility in the price of my investments, independent of whether the assets underlying value has changed’?

Volatility = Jumpiness

Volatility is a word that you would have seen and read a lot about over the last few weeks, so let’s ensure we know what it means.

Firstly, I am going to replace the word ‘volatility’ with ‘jumpiness’. Volatility is one of those fancy words that means nothing but is used all the time and often way out of context!

Behind an investment growth potential, its jumpiness is the second most prominent feature. Basically, jumpiness in the up and down price moves of your investment portfolio. Its what inspires short term and often bad decision making. Investors tend to sell low and buy high due to jumpiness, which undermines their own financial futures.

Jumpiness is the emotional cost of achieving the growth we seek, need or want. Long term growth charts of equites and bonds show how remarkable an investment can appreciate over time but such charts don’t give us any sense of how difficult it is to hold onto those investments during the many rough patches we will encounter along the way.

The ride absolutely matters!

Even though jumpiness is much more predictable than returns (we know that our investments will move up and down in the lifetime of us holding them but we simply don’t know the returns we are going to achieve), that jumpiness encourages bad decisions along the cycle of greed (buying high) and fear (selling low)

Ultimately, jumpiness is the ‘price of admission’ for access to potential gains.

Numerically, jumpiness is a tough concept to get your head around (the global equity market historically has a jumpiness of 17 – a number with no intuitive meaning!)

Jumpiness in its purest sense is an emotional feeling and the best way to make it far more emotionally relatable is to put it in the context of drawdown, a closely related and similar concept.

Reactions and Actions

Drawdown is the depth of the real-world decline in any particular market, asset class or other investment.

Drawdown has a behavioural cost, the next table is hardly scientific, to say the least but it is based on impressions and emotional reactions of how investors deal with losses.

As the losses grow, affect turns increasingly negative and actions grow more extreme. The deeper the drawdown, the more painful the ride!

NEWSFLASH! – successful investing is emotionally painful!

Having the right mindset is critical but achieving our desired outcomes can be taxing. We’re torn! We feel compelled to take control, to lean in. But at the same time, we know there is wisdom in letting go, allowing well made plans to run their course. We would love to do nothing, but oddly it takes a great deal of foresight and willpower to do so, doing nothing is denying the alluring power of now.

 

 

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