That may not last, however. The average monthly total return – up or down – is 3.4% (absolute value). The previous month’s decline of 3.2% is thus not just a striking contrast; it is squarely within what can be expected. Annualised volatility, a commonly reported number, is 16.1% for the full period since inception at the end of 1969.
Too bumpy for you?
Let me then remind you that one year is an arbitrary measurement period. You don’t invest in stocks to sell them on a Friday at 4 p.m. after exactly 12 months, and if you invest in equity funds, you are likely to be advised that you should have an investment horizon of at least five years.
So, let’s see how risk looks with a five-year horizon. Volatility, measured as the standard deviation of your annualised five-year returns, is now a lot less scary figure: 7.2%. Extending the investment horizon to five years thus more than halves this measure of the price swings you see in your monthly reports. And it’s reduced even further, to just 6.4 %, if we start counting at the end of 1989.
That’s the starting date for the fixed-income index Bloomberg Global Aggregate, which comprises global investment-grade bonds. This index has an annualised volatility of 6.8 %. While not quite comparable to the five-year measure of the stock index, I do hope you notice that it’s actually a higher figure. Extending the horizon to five years of course makes for lower volatility in the Bloomberg Global Aggregate Index as well: 3.1%.
The point I’m trying to make here is that risk depends as much on your investment horizon as on your investment vehicle.
By definition, risk is neither predictable nor constant. For the MSCI World Index, the past decade has been noticeably calmer. It doesn’t really make sense to measure the volatility of five-year returns over such a short spell, but you may find reassurance in the fact that the regular measure of volatility now drops to 12.4%.
It could have been worse. You could have invested in, say, the S&P U.S. Treasury Bond 10+ Year Index. This index consists of only US government bonds. Pretty safe stuff, I reckon. Nevertheless, over the very same decade, it has a volatility score of 14.3% – clearly above the world index, that is.
The reason of course is the long duration, close to 15. While credit risk is inarguably low, it has interest rate risk to boot.
Risk obviously comes in many shapes and sizes. It may not even make sense to use volatility as your primary gauge. But that’s another story.
Finn Øystein Bergh
Chief Economist & Strategist
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