Imagine a world where you could choose where to live based on climate alone. In one corner, you have the picturesque Southwest Florida, known for its warm subtropical weather and relatively mild seasonal temperature swings. In the other corner, there's the breathtaking Sahara Desert, notorious for its extreme temperature fluctuations and harsh living conditions. The decision might seem like a no-brainer: Who wouldn't want to live in a more comfortable and predictable environment like Florida?
When it comes to investing, many people find themselves facing a similar choice: Do they opt for a stable, well-diversified investment portfolio that provides consistent returns with lower volatility, or do they pursue a more aggressive, high-risk strategy that offers potentially higher returns but also greater potential losses?
Investing is a lot like choosing your ideal climate. You want to strike a balance between risk and reward that suits your personal preferences and financial plan. This is where the concepts of portfolio volatility and diversification come into play. These are fundamental concepts for all investors, and this article is the second in my series of Investor Basics.
Volatility refers to the degree of fluctuation in the value of an investment or a portfolio over time. Higher volatility implies a greater range of potential gains and losses, while lower volatility suggests more stable and predictable returns. Diversification is the practice of spreading your investments across various asset classes, sectors, and geographic regions with the aims of lowering portfolio volatility, reducing risk, and achieving more consistent returns.
The Investment Climate: South Florida and the Sahara Desert
Many people would be surprised to find out that mild South Florida and the extreme Sahara Desert have almost the same average year-round temperature. Although the desert is hotter as most people would assume, it is also colder! Here is a table with the data, in degrees Fahrenheiti :
While South Florida and the Sahara Desert share similar long-term temperature averages, South Florida offers a less volatile experience, with milder seasonal and daily fluctuations.We could say that South Florida's climate has "a narrower range of expected outcomes" than that in the Sahara Desert, and that it is this narrowness, not the average, that makes it a comfortable place to be. This climate comparison reflects the concepts of volatility and diversification in investing.
Volatility refers to the degree of fluctuation in an investment's value over time, capturing both positive and negative price movements.People frequently misinterpret market volatility as exclusively representing declining markets. Informed investors should remember that volatility is not exclusively about declining markets but rather encompasses the entire range of possibilities.
South Florida represents a well-diversified and properly allocated portfolio, with the mild climate mirroring the stability and predictability of a diversified investment strategy. By contrast, the Sahara Desert symbolizes a concentrated, high-risk portfolio, with extreme temperature swings akin to significant fluctuations in value.
The Florida-Sahara metaphor serves as a powerful reminder of the importance of understanding your risk tolerance and investment goals. Whether you prefer the stability of a diversified portfolio or are willing to embrace the potential volatility of a high-risk strategy, or some combination of the two, the key is to find an investment approach that aligns with your unique circumstances, preferences, and plan. By keeping the correct meaning of volatility in mind, investors can make more informed decisions and be better prepared for the range of outcomes in their investment journey.
Best regards,
Frank Hujsa, CFP®, CLU®
Partner, Acadium Financial Partners
Financial Adviser, RJFS
C 239.207.4392
27499 Riverview Center Boulevard, Suite 108
Bonita Springs, FL 34134
Frank.hujsa@acadiumfinancial.com
www.acadiumfinancial.com
Any opinions are those of Frank Hujsa and are not necessarily those of Raymond James. Securities offered through Raymond James Financial Services, Inc. member FINRA/SIPC. Acadium Financial Partners is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment Advisory Services offered through Raymond James Financial Services Advisors, Inc.
Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance does not guarantee future results. The information provided has been prepared from sources believed to be reliable but is not guaranteed by Raymond James Financial Services and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for informational purposes only and does not constitute a recommendation. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Dividends are not guaranteed and must be authorized by the company's board of directors.
i Sources: https://biomania-saharadesert.weebly.com/climatelocation.html and https://www.ncei.noaa.gov/access/us-climate-normal-1981-2010?bbox=-87.56,24.31,-75.18,31.04&units=standard
Temperatures are in degrees Fahrenheit and are approximate.