What does volatility mean for your super?

The word ‘volatility’ is used to describe significant fluctuations in investment performance.

But what does it mean exactly?

Does it really refer to a period of negative returns?

And how does it matter to your investment option selection?

We answer these common questions below.

What does volatility mean exactly?

It refers to changes in the value of investment returns for a given financial market (e.g. the ASX200) or investment (e.g. company shares in the big miners or banks) over different time periods. The variability of returns can be classified as either normal, or higher than normal (i.e. a period of volatility). For example, when the variability of global sharemarket returns increases beyond a normal range, you’ll probably hear the word ‘volatility’ used by the media more often.

And that’s when you may wonder: What’s causing this investment volatility?                                             

What causes volatility?

A number of factors can cause market volatility. One notable example is uncertainty... if market participants are more uncertain than normal about the future direction of prices for a given market, their fear levels rise and the likely variability of returns is also likely to be greater than normal.

For example, the short-term variability of global sharemarket returns increased due to uncertainty surrounding the prospects for the Greek economy in June 2015 (when in technical default of its loans) and China in August 2015 (due to insufficient transparency in its stock market and policy implementation). Investors were more uncertain than normal at those times about the future direction of sharemarket prices. That increased uncertainty caused a period of negative returns.

Are volatility and negative returns the same thing?

Volatility and negative returns are not the same thing, even though investment volatility may result in negative returns. But we understand why people may think using the word volatility means negative returns. Reason being, media commentators may say ‘volatility’ when they really mean ‘price falls’ for a given market or investment (i.e. the word ‘volatility’ is often used to describe a market or investment downturn). The same media commentators tend to ignore periods of market volatility when prices are increasing at a faster than normal pace. However, such episodes are just as accurately defined as instances of market volatility.

But whether markets increase or decrease at a faster than normal pace, history says these episodes of volatility come to an end…

What halts volatility?

Generally new information halts volatility… which either provides investors with a clearer direction of the likely future path of both economies and markets, or changes investor perceptions about the direction of market movements. For example in June 2015, the unveiling of a European bailout package for Greece brought an end to investor uncertainty and fear over the country’s short-term fortunes. This was sufficient to see volatility levels decline noticeably.

Do prices automatically rise when volatility is reduced?

If volatility decreases, market or investment prices won’t necessarily rise (in the same way ‘volatility’ shouldn’t mean or imply an upcoming period of negative returns). Instead, reduced volatility may result in prices rising, falling or remaining unchanged (i.e. prices remain spread within their normal dispersion for that market or investment).

For example, prices will rise or remain unchanged when new information received by market participants shakes-off any undue concerns or uncertainty. When prices fall, new information has eroded market support of a previous fundamental price range.

But the question you probably want answered is:

How does volatility affect my investment option selection?

And the answer is short-term investment volatility should not drive long-term investment decisions for your super. That’s because short-term fluctuations (both up and down) to your super balance caused by investment volatility is not an accurate predictor of the long-term investment performance of your chosen investment option.

To select your appropriate investment options, you may instead prefer to consider:

  • how much super is needed to meet your retirement income needs
  • the level of investment performance you may need to achieve your savings target, and
  • your investment timeframe (i.e. the length of time until you retire).
  • Learn how to set a saving target for your super.

But still, it can be unsettling to hear lots of media talk about investment volatility.

I'm worried about volatility, what should I do?

We encourage you to consider personal financial advice. A qualified financial planner you trust can help calculate how much super you need to save and recommend the appropriate investment option selection for your savings target, investment timeframe and other circumstances.

General advice

This PSSap article provides general information only. It has not taken account of your personal objectives, financial situation or needs. Before acting on any general information or advice, you should have regard to your own objectives, financial situation and needs.