A recent article penned by Motley Fool writer Morgan Housel described some of the basic principles that need to be understood to invest successfully.
Morgan believes that one of the key things investors need to understand to succeed in the long-term is the difference between volatility and risk.
Avoiding the market
A report produced by the ASX in 2012 showed that direct participation in the sharemarket amongst Australia's adult population had decreased considerably since 2010, falling from 39% to just 34%.
Meanwhile, the report showed that 'perceived share market knowledge' had declined since 2008 (when the Global Financial Crisis struck) with the number of participants believing they are knowledgeable falling below 50%.
It's likely that many investors remain cautious of the sharemarket due to the violence of the GFC, which saw the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) more than halve in value. A number of widely-held companies such as Commonwealth Bank of Australia (ASX: CBA), Woolworths Limited (ASX: WOW) and Telstra Corporation Ltd (ASX: TLS) were also hit for six, wiping out the market's confidence.
Volatility vs. Risk
It is in the market's nature to be volatile and occasionally we will endure a crash similar to the one experienced in 2008-09. Shares will move up and down based on earnings cycles, economic headwinds and, more often than note, the mood of investors.
This volatility creates risk. Volatility can be a long-term investor's best friend because it can create incredible opportunities to buy shares at discounted prices when others are running fearful. As Warren Buffett once said: "Be fearful when others are greedy and greedy when others are fearful."
On the other hand, "risk is your own tendency to react (to these) ups and downs by buying high and selling low", as defined by Morgan Housel. In other words, risk is the tendency of investors to react to volatility in a negative way, giving other investors the opportunity to buy low and sell high.
In relation to the statistics mentioned above, there is also a great risk in not investing in the sharemarket due to the fear of volatility. Those investors who sold out during the depths of the GFC and have avoided the sharemarket ever since have also missed out on an incredible 80% run from the ASX 200, and that's not even including dividends.
Now that's risk!
As 'Foolish' readers will know, The Motley Fool is all about investing for the long term and ignoring any short-term market fluctuations. In saying that however, we do love to take advantage of a market-wide selloff (as we've endured in recent months) to buy high-quality companies trading at reasonable prices, including ResMed Inc. (CHESS) (ASX: RMD) and G8 Education Ltd (ASX: GEM) – both of which I have my eye on right now.
