If you’ve spent time searching for the best potential investment opportunity, there’s no doubt that you’ve encountered the term ‘volatility’. For the most part, volatility is a measure that should be carefully considered when it comes to investing. For this reason, investors entering the investment game often ask, “Which asset classes are the least volatile?”
Now, between real estate and the stock market, real estate is generally considered less volatile than stocks. However, in order to invest in the right asset class based on your risk appetite, you must understand what volatility is.
Here’s everything you need to know about volatility, along with why investing in real estate provides a bit more comfort compared to the stock market.
What Is Volatility?
Volatility describes how much an asset moves around in price, be it up or down, over a given period of time. The more frequent and drastic an asset’s price zigzags (high peaks, low troughs), the more volatile and unstable that market is said to be. To help you mentally picture volatility, then imagine the scariest rollercoaster in the world, full of unpredictable twists and turns – quite daunting, right?
On the other hand, asset prices with more incremental and smooth fluctuations are considered less volatile and therefore more stable. However, keep in mind that market volatility is actually a completely normal part of investing. After all, if markets were always on the up, then investing would be easy as pie, meaning we’d all be happy and rich.
Volatility And Risk
But why is volatility a problem? At the end of the day, volatility is an important measure of an asset’s risk, and, in most cases, a more volatile investment is riskier than a less volatile one. Now, the problem is that more volatile assets make it exceedingly difficult to predict whether the price will go up or down in the future.
That said, risk and reward tend to go hand in hand in investing. So, if you want the chance to make big gains in a month by investing in a more risky, or volatile, asset, you also have to come to terms with the fact that the asset price may very well drop to zero in a month, too.
Evidently, predicting where an asset’s headed is definitely no walk in the park. And, although volatility is arguably the most important measure of risk, it misses out on some other types of risk, such as the risk of your money losing its value to inflation over time.
Low Volatility Vs High Volatility
When should you invest in assets with low volatility vs assets with high volatility? Well, that depends on your timeframe and risk appetite. So, if you’re looking to buy a home in the next year, you’d probably want to make less volatile investments, as you want to ensure your money is there when you need it to make that purchase.
However, if you’re looking to take the risk and make big gains on an investment, then you’d probably want to invest in something with higher volatility, though that comes with the risk of losing what you invest.
Nowadays, volatility is typically associated with stocks and cryptocurrencies, where prices fluctuate daily. (In fact, before cryptocurrencies were a thing, stocks were considered the most volatile.) This was evident when the Dow Jones Industrial Average lost 37% of its value in a little over a month when Covid-19 first hit. In subsequent months, however, the stock market rebounded almost as quickly as it dropped. See that? Volatility at its best and worst.
So, for more speculative investors, with large, established portfolios and a high-risk tolerance, then investing in more volatile assets, like stocks and crypto, in the hopes of making great returns is reasonable enough. But, those who want to build long-term wealth should invest in assets that are less volatile and more predictable – like real estate.
How Is Real Estate Less Volatile Than Stocks?
Before we shed some light on what makes real estate less volatile than stocks, it’s important to note that both the stock market and real estate come with their own pros and cons. Still, real estate is growing in popularity by the day, as low volatility gives real estate the edge over the stock market, and here are some reasons why:
1. Longer-Term Holds
Real estate investments, unlike stocks, typically work in years, not days or weeks. Generally, real estate investors are recommended to hold their investment for a period of at least two years, and even as many as ten.
This means your real estate investment can overcome any current market volatility, allowing you to sell your property at any given chance the market is more stable and thriving. Plus, since your investment in real estate is generally illiquid, this means you can’t sell your asset in a moment of panic, which tends to happen a lot in the stock market!
2. Tangible Asset
A more notable distinction between real estate and stocks is that real estate is a physical, finite asset with limited supply. While more properties can be built over time, there is only so much space available. And, as demand increases, the value of real estate assets appreciates accordingly.
Essentially, investing in real estate gives access to a tangible, scarce asset, while also providing complete control over your investment. Not to mention, properties can be renovated, reconstructed, or repaired to increase their potential value, unlike stocks that are effectively just a piece of paper.
3. Non-correlated Asset
While some stocks may see big swings in a single day, real estate is less susceptible to price swings as it is less tied to market fluctuations. In fact, any real estate value changes in the same period as stocks are minuscule and may not even be detectable at all, as there is very little correlation between the two assets.
Real estate values are actually often more impacted by local market drivers, like whether it’s peak season or if there’s an ongoing event in the area. In fact, events that have the capacity to impact the entire financial system, e.g. wars, are more likely to affect property values than fluctuations in the stock market. What’s more, real estate is known to be an excellent inflation hedge as its intrinsic value helps outpace the inflation rate, keeping its value intact.
4. Easier To Predict
Stocks can fluctuate several times a day, with prices swinging dramatically. This can be beneficial as investors can buy at the dip and sell when the price peaks, but that still proves to be quite risky and unpredictable. Since stock market volatility has little correlation with the real estate market, owning real estate tends to offer some protection against market downturn.
Overall, real estate doesn’t suffer from the same uncertainty and unpredictability that affects stocks, as the stock market is incredibly vulnerable to sudden changes, leading to sharp plummets in prices, or even a crash.
With real estate being an easier asset class to predict, buying low and selling high is a more likely scenario as it is virtually impossible to predict if the value of a stock will rise or slump in the future, which is not the case with real estate.
One of the key advantages of investing in real estate is the decreased volatility when compared to the stock market. Since volatility describes how bumpy or smooth an asset’s price changes are, the more volatile an investment, the riskier it generally is, as risk and volatility are deeply intertwined.
Frankly speaking, volatility is something every investor will face, and it’s actually worthwhile to point out that volatility can sometimes be a good thing, considering it can make you rich overnight! However, overnight millionaires can still lose it all the very next day.
That’s why real estate investments can be an effective addition to a well-diversified portfolio and help protect your portfolio from excess volatility. Generally, there is more stability and less risk involved in real estate as compared to fluctuating stock prices as you don’t have to worry about the market ups and downs to reflect on real estate.
As always, it’s important to understand the volatility of any investment you’re considering to ensure that it’s a good fit for your financial objectives, risk tolerance, and portfolio balance. With platforms like SmartCrowd breaking down barriers to real estate investment, just about anyone can add real estate to their portfolios with ease. You could even start with as little as AED500, diversify across several properties and start earning consistent returns!