A Misconception About Investing Risk and Market Volatility

 Volatility ≠ Risk

When it comes to investing, there’s a big misconception that volatility equals risk. It’s something you hear all the time in the financial world—news headlines flash with “market volatility,” analysts fret over fluctuating stock prices. Many investors start to panic the moment they see red on their portfolios. But for those of us who take a long-term, value-focused approach, we know that volatility is not something to fear. In fact, volatility is our friend.

Remember as I always mentioned: Crisis = Danger + Opportunities

危机 = 危险 + 机会

 

What Is Volatility, Really?

Volatility is basically how much and how quickly the price of a stock or asset moves up and down over a given period. It’s typically measured by the standard deviation of returns—yes, all that maths stuff you might have learned in finance class. But don’t get too caught up in technical terms. Volatility just means the price is bouncing around more than usual.

Now, many see this price bouncing as a sign of danger. After all, who wants to see the value of their investments going on a rollercoaster? But here’s the thing: unless you’re a short-term trader or someone who needs their cash tomorrow, you don’t need to stress out about those price swings.

 

Why Volatility Is Not Risk

Let’s get one thing clear about risk, in its true form, is about losing money permanently. You invest $10,000 into a stock, and it drops to $5,000... and never recovers. That’s risk. You’ve lost that money, and it’s not coming back, like investing in penny/meme or speculative stocks.

Volatility, on the other hand, is just temporary noise. It’s the ups and downs that happen daily, weekly, even yearly, but it doesn’t mean you’ve lost anything unless you sell at a loss. So, for long-term investors like you and me, who can stomach a bit of turbulence, volatility doesn’t pose the same threat as it does to someone looking for a quick buck.

In fact, volatility creates opportunities. When everyone is panicking, prices often get irrationally low. And that’s when we, the smart money, come in. We buy quality stocks at a discount, knowing that once the market calms down, their true value will shine through.

Mr. Market and Irrational Moves

This brings me to one of my all-time favourite investment concepts from the legend Benjamin Graham—Mr. Market. Think of the stock market as this emotional, erratic guy who offers to buy your shares one day for $100 and the next day for $50, all based on his mood swings.

Mr. Market is unpredictable. Some days he’s super optimistic, other days he’s in despair. But as investors, we don’t need to follow his emotional rollercoaster. We just need to recognize when Mr. Market is giving us a good deal.

Benjamin Graham taught us to focus on the intrinsic value of a company. This is the real worth of the business, based on its earnings, assets, and growth potential—not the daily price fluctuations driven by Mr. Market’s moods. When the market prices a stock way below its intrinsic value, that’s your opportunity to buy.

And guess when these discounts happen most? That’s right—during periods of high volatility.

 

What Warren Buffett and Peter Lynch Think About Volatility

Take a leaf out of Warren Buffett’s playbook. He’s famous for saying, “Be fearful when others are greedy, and be greedy when others are fearful.” That sums up the value investor’s relationship with volatility.

When markets are falling, and everyone is running for the exits, that’s when you should start looking for bargains. Why? Because during these volatile times, even great companies with strong fundamentals can get swept up in panic. The key is to know the value of what you’re buying.

Peter Lynch, another legendary investor, once said, “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.” Translation: Don’t try to time the market, don’t worry about volatility, just buy solid companies and hold them long-term.

Both Buffett and Lynch didn’t just tolerate volatility—they used it to their advantage. They knew that volatility is a normal part of market cycles. What matters is not the short-term price movements but the long-term performance of the business.

 

The Problem with Seeing Volatility as a Risk

Now, why does the financial industry push the idea that volatility is risk? It largely comes from modern portfolio theory, which ties risk to volatility. The higher the volatility, the higher the “risk,” or so the theory goes. This idea gets reinforced by tools like the Sharpe ratio, which penalizes investments that fluctuate a lot, even if those fluctuations lead to big gains in the long run.

But here’s the flaw: by focusing so much on volatility, investors can miss out on the real risks. The real risk isn’t price swings—it’s buying bad businesses or overpaying for stocks. If you’ve done your homework and bought a fundamentally strong business at a reasonable price, then short-term volatility doesn’t matter. The stock will eventually reflect the company’s true value.

Benjamin Graham’s “Margin of Safety”

Benjamin Graham was a master at reducing real risk, and his strategy for doing so was simple—use a margin of safety. The margin of safety is the difference between a stock’s price and its intrinsic value. The bigger the margin, the less likely you are to lose money over the long run.

By buying stocks at a deep discount, you protect yourself from errors in your analysis or unforeseen market conditions. Even if the market goes south for a while, your investment still has a buffer, reducing the chances of permanent loss.

This concept aligns perfectly with the idea that volatility is not risk. If you’ve got that margin of safety, short-term volatility becomes irrelevant. You’re insulated from the market’s emotional swings.

 

How We Can Use Volatility to Our Advantage

As value investors, we should be excited about volatility because it gives us opportunities to buy good companies at cheap prices. Market corrections, economic downturns, and global events all lead to increased volatility. But remember, these events don’t destroy strong businesses overnight. What they do is create a temporary mispricing in the market.

When volatility spikes, most investors react emotionally. They sell at the bottom and miss out on future gains. But we do the opposite. We keep a cool head, study the fundamentals, and take advantage of the dips.

In a way, volatility acts as a tool for us. It shakes out the weak hands, the speculators, and the short-term thinkers, leaving the true bargains for those willing to look past the short-term noise.

   

In Howard Marks' latest YouTube video, "How to Think About Risk,"

Howard Marks emphasizes that traditional academic definitions of risk—such as volatility, standard deviation, or Value at Risk (VaR)—are flawed in assessing the true nature of risk in the market. He challenges the conventional academic definitions of risk, according to Marks, these measures are insufficient in capturing the real essence of risk for long-term investors. Volatility merely reflects short-term price fluctuations, which do not accurately represent the risk that matters: the possibility of permanent capital loss.

 Marks believes that real risk comes from the possibility of permanent capital impairment, driven by bad decisions, deteriorating fundamentals of an investment, or paying too much for a stock. He stresses that investors should focus more on understanding the business and its intrinsic value rather than short-term price movements.

He also highlights that risk in the market is often tied to psychological factors. When market participants become overly optimistic, they drive up prices to unsustainable levels, increasing the likelihood of future corrections. On the other hand, when fear dominates, opportunities arise for savvy investors to buy undervalued assets. For Marks, understanding risk requires a deep knowledge of market cycles and human behavior, rather than relying on mathematical models that reduce risk to a set of numbers like standard deviation.

Marks emphasizes that true risk arises when an investor permanently loses capital due to poor investment decisions, deteriorating company fundamentals, or overpaying for an asset. He dismisses the idea that price volatility should be feared, as it doesn’t necessarily indicate that the business itself is in trouble. Instead, volatility can present opportunities to buy quality assets at discounted prices, as long-term investors should focus on the underlying business, not day-to-day price swings.

He also delves into the psychological aspects of risk, explaining that market sentiment often amplifies risk. When investors become overly optimistic, they drive asset prices higher, often beyond their intrinsic value, which increases the potential for future corrections. Conversely, when fear and pessimism dominate the market, prices tend to fall below intrinsic value, creating opportunities for astute investors to buy undervalued assets.

Marks argues that successful investors understand that risk is deeply tied to market cycles and investor psychology rather than academic models. He encourages investors to focus on fundamentals and value, rather than being influenced by market noise and short-term volatility. By doing so, investors can better manage risk and take advantage of market inefficiencies created by emotional swings, thereby enhancing their long-term returns.

This is a good YT to explain the Market or Investing Risk and I hope you enjoy watching it:

Now, if you look at below “Regression Line “from most of the stock market, it bounces up and down in the long run. Market drawdowns of 10-20% are common due to natural market cycles, driven by factors like economic data, interest rate changes, geopolitical events, and investor sentiment. These swings reflect short-term reactions, not long-term fundamentals, and are a normal part of the market’s ongoing price discovery process.

<Image credit: Carson.com>

Market volatility, much like the changing seasons, is a natural part of the investment landscape. Just as winter always gives way to spring, market cycles move through phases of growth, contraction, and recovery. Investors often fear volatility, seeing it as a risk, but history shows that markets tend to revert to the mean over time. This means that extreme highs and lows are temporary, with prices eventually settling around their long-term averages.

In the short term, sentiment and external shocks can drive markets to swing wildly. However, over the long run, fundamentals like earnings, cash flow, and economic growth dictate the true value of assets. Just as no season lasts forever, neither do market booms or busts. By understanding this cyclical nature and focusing on long-term value, investors can weather market storms and benefit from the inevitable "reversion to mean", capturing growth when calm returns.

<Image credit: Zeevyinvesting.com>

<Image credit :www.Vaneck.com>

Like the recent Hang Seng Index, it shot up by almost +36% in just 2 weeks and about +54% from a year low. This is an increase of about HKD 6 Trillion in market capitalization (wealth effect) in a few weeks. The stock market sentiment could just swing with the sudden change in policy direction or narrative about the future of the economic situation. The change of mood/narrative in the HK market was caused by the announcement of a slew of new stimulus packages or measures by MOF / PBoC on 24 September 2024, including cutting the interest rate RRR by 50 bps, freeing up about 1 trillion yuan for new leading. Also, additional measures like the issuance of more LT bonds to support the property market, providing swap facilities with new funds for companies to do share buyback (500 billion yuan or more) and setting up a central support fund to stabilize the capital market.

This policy announcement has successfully unleashed the “animal spirit” of investors in the short term, but in the long run, we will still need to see an improvement in the company's earnings or overall economic situation

As we know, monetary policy is meant to influence the short-term capital flow within the system but for long-term economic growth, it will still need to follow up with a fiscal policy to address or solve the long-term structural problems in housing and local government debt issue.

As such, the China Ministry of Finance held a press conference on the 12^th of October 2024 where the officials spoke about defusing local debt risks and stabilizing the property market, adding the central government “has room” for further action and higher deficits. A specific figure for fiscal stimulus was not revealed.

 

7 major takeaways

The finance ministry reiterated the central government still has “room” to raise debt and the fiscal deficit, but didn’t reveal any broad-based stimulus measures markets were hoping for.

The headline policies announced at the ministry’s conference were as follows:

• Allocate 400 billion yuan (US$56.57 billion) from the local government debt balance limit to expand local financial resources.

• Tap funding from an unused bond quota of 2.3 trillion yuan (US$325.3 billion) for local governments.

• Introduce a one-time, large-scale debt ceiling increase for local governments to swap their hidden debts.

• Allow local governments to use special bonds to purchase idle land from troubled developers.

• Use special bonds to purchase existing commercial homes. Earmark more funds for offering government-subsidized homes, and less on building new homes.

• Optimize tax policies and study the abolition of value-added tax on ordinary residential buildings.

• Double the quota for college student subsidies and increase the per-person amount.

 

I am not sure how the market will react to this announcement but I think we should look at it in a more holistic way that the government is determined to solve the long-term structural issues like local government debt and housing issues which I have mentioned before that the housing problem is the “ mother of all problem” unless we see the government put in real $$ to solve or at least stabilize or stop the vicious cycle, it will be tough as the economy growth will be dampened by this so-called “ balance sheet repair” where peoples are doing the “ de-leveraging” rather than investment or spending.

As we all know, investing in China or rather the HK market is very much “policy-driven “where a sudden change in policy direction will have a big impact on a certain industry in particular or the economy in general, like the past few years of policy on curbing [property speculative and tech crackdown.

The China Politburo Standing Committee meeting on September 26, 2023, is significant because it signals a potential shift in policy direction to address critical issues in China’s economy, particularly the housing crisis and local government debt. The Politburo’s emphasis on stabilizing the housing market could indicate the government’s readiness to ease restrictions, provide more liquidity to developers, and encourage homebuying with more favourable policies. This would mark a shift from the previously stringent "three red lines" policy, which curbed developer borrowing and contributed to the sector's financial stress.

 

 Conclusion: Embrace Volatility, Ignore the Noise

 Obviously, volatility isn’t something to be feared—it’s something to be used. If you’re investing with a long-term horizon, short-term price movements won’t make or break your portfolio. What matters is buying solid businesses at reasonable prices and holding them as they grow over time.

So, next time the market gets volatile, don’t panic. Instead, think of it as an opportunity. Look at it the way Warren Buffett, Peter Lynch, and Benjamin Graham would—volatility isn’t a risk, it’s a chance to buy great companies on sale. By understanding this and sticking to a disciplined, value-based strategy, you’ll be well-positioned to grow your wealth while others get caught up in the market’s emotional swings.

But again, one must take into consideration his/her “risk tolerance” in portfolio management, as some markets are typically much more volatile than others, it is good that you only invest in the market to the point that you can “stomach the volatility” or “sleep well” in the night. 😊

 

Till next update!

 

Cheers …. 😊

 

STE