Understanding Volatility

One of the most important factors influencing our financial lives today is the notion of volatility. At its basis, volatility is the rate at which the value of an investment or stream of cash flows will vary over time. People who owned real estate in California, Las Vegas, Florida, or the Northeast over the last few years are very well associated with the notion of volatility, since the values of their properties shot up like a rocket and then crashed back down to earth like a rock.

The principal is critically important to our investing life, since the value of most people’s portfolio is based on the value of its underlying securities (mostly stocks), which have a tendency to fluctuate on a regular basis. In the not too distant past, this fluctuation was relatively light. However, recent years have seen an acceleration of price volatility up to unprecedented current levels. The important thing to consider in regards to volatility is that when asset price volatility increases, the timing of when you buy or sell becomes more important. This stands in contradiction to the traditional orthodoxy of ‘buy and hold’ for long-term investors, but the vast swings of market values in recent years is providing an increasing amount of resistance against this conventional wisdom.

In contrast to volatility, you have stability. In the context of investments, stability generally takes the form of cash flows from dividends, interest payments, or rent revenue. As the volatility of stock, bond, and real estate values continue to increase, the stability of cash flow will become a more important part of prudent investing strategies. In the context of earnings, most people acquire cash flows from a job. Some people have volatility in their income from commissions, but many people have relatively stable cash flow that they earn and relatively volatile values when they invest. As the trend of value volatility continues to impact the financial markets, the time for a new model of financial investment to emerge is drawing near.

The most likely vehicle for this new model of investing is in the realm of investment real estate and income properties. The reason for this is because income properties are fragmented in local markets that do not fluctuate directly with the financial markets. Furthermore, income properties can be financed with leverage and produce regular cash flows. This gives prudent investors who pursue income properties an opportunity to realize a level of stability in their investments that is no longer available in the financial markets.

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