By the end of this lesson you understand why an investment's time horizon changes the correct way to manage the risk being taken on.
\nTime horizon is the period of time during which an investor plans to hold an investment before needing to get the money back. It isn't a property of the asset -- it's a decision made by the investor, depending on what they need that money for and when.
\nTime horizon doesn't change an asset's intrinsic risk -- a stock is just as volatile regardless of the horizon you view it through -- but it does change the correct way to manage that risk. With a long horizon, there's more time ahead for short-term ups and downs (the volatility you saw in the previous lesson) to even out before the money is needed. With a short horizon, on the other hand, whatever result exists at the specific moment the money is needed is the one that counts, with no room to wait for a drop to recover.
\nThis has an important practical consequence: the same investment can be reasonable for a long horizon and risky for a short one, without the asset itself having changed at all. It's not that the asset becomes "safer" over time -- it's that the horizon determines how long the investor can afford to wait before having to accept whatever result exists at that moment.
\nInvesting in a stock intending to use that money in thirty years gives plenty of room for short-term price swings to even out before the money is needed. Investing that same amount in that same stock to cover an expense in three months doesn't give that room -- if the price has dropped right when it's needed, the investor will have to accept that result, with no time to wait for a recovery.
\nTime horizon is how long an investor can hold an investment before needing the money. It doesn't change the asset's risk, but it does change the correct way to manage it: a long horizon gives room for short-term volatility to even out; a short one forces you to accept the result of the moment.
\nWhy can the same investment be reasonable with a long horizon and risky with a short one?
\nWhat's the difference between "an asset's risk" and "the room a time horizon gives for managing that risk"?
","sortOrder":4,"readingMinutes":5,"difficulty":"Básico"},"previous":{"id":12,"moduleId":4,"slug":"what-is-volatility","title":"What is volatility?","summary":"You understand what volatility is, how it relates to risk, and why it isn't the only way of measuring it.","bodyMarkdown":"## Objectives\n\nBy the end of this lesson you understand what volatility is, how it relates to risk, and why it isn't the only way of measuring it.\n\n## Content\n\nVolatility measures how much an asset's price varies over a given period of time. A highly volatile asset is one whose price rises and falls frequently and sharply; a low-volatility asset tends to move more gradually and predictably.\n\nVolatility is one of the most common ways of measuring an investment's risk -- but, as you already saw in this module's first lesson, it isn't the same as risk in its full sense, only one of its possible measures. It's a particularly useful measure because it's directly observable from the price, with no need for additional estimates: you just need to look at how much an asset's price has moved in the past to get a sense of its historical volatility.\n\nHowever, volatility doesn't capture everything that makes up an investment's real risk. A bond can have relatively low day-to-day price volatility and still carry default risk -- the possibility that the issuer won't pay, something volatility alone doesn't reflect until it happens. That's why it's better to treat volatility as a useful tool for approximating risk, not as its complete definition.\n\nIn general, and consistent with the risk-return relationship you already saw, assets with higher volatility -- like stocks of small or less established companies -- tend to offer a higher expected return than assets with lower volatility, like bonds from governments with solid finances.\n\n## Example\n\nA young tech company's stock price can rise or fall several percentage points in a single day, while a bond from a government with solid finances barely moves day to day -- the stock is, in this sense, much more volatile than the bond.\n\n## Common mistakes\n\n- Confusing volatility with risk in general -- volatility is one way of measuring risk, not its complete definition; some risks, like default risk, aren't always reflected in advance by price volatility.\n- Thinking a low-volatility asset is risk-free -- it only means its price varies little in the short term, not that it can't have other risks.\n\n## Summary\n\nVolatility measures how much an asset's price varies over time, and it's one of the most common ways -- though not the only one -- of measuring risk. More volatile assets generally tend to demand a higher expected return.\n\n## Self-check\n\nWhy isn't volatility exactly the same thing as risk?\n\nWhy can a bond with low price volatility still carry risk?","bodyHtml":"By the end of this lesson you understand what volatility is, how it relates to risk, and why it isn't the only way of measuring it.
\nVolatility measures how much an asset's price varies over a given period of time. A highly volatile asset is one whose price rises and falls frequently and sharply; a low-volatility asset tends to move more gradually and predictably.
\nVolatility is one of the most common ways of measuring an investment's risk -- but, as you already saw in this module's first lesson, it isn't the same as risk in its full sense, only one of its possible measures. It's a particularly useful measure because it's directly observable from the price, with no need for additional estimates: you just need to look at how much an asset's price has moved in the past to get a sense of its historical volatility.
\nHowever, volatility doesn't capture everything that makes up an investment's real risk. A bond can have relatively low day-to-day price volatility and still carry default risk -- the possibility that the issuer won't pay, something volatility alone doesn't reflect until it happens. That's why it's better to treat volatility as a useful tool for approximating risk, not as its complete definition.
\nIn general, and consistent with the risk-return relationship you already saw, assets with higher volatility -- like stocks of small or less established companies -- tend to offer a higher expected return than assets with lower volatility, like bonds from governments with solid finances.
\nA young tech company's stock price can rise or fall several percentage points in a single day, while a bond from a government with solid finances barely moves day to day -- the stock is, in this sense, much more volatile than the bond.
\nVolatility measures how much an asset's price varies over time, and it's one of the most common ways -- though not the only one -- of measuring risk. More volatile assets generally tend to demand a higher expected return.
\nWhy isn't volatility exactly the same thing as risk?
\nWhy can a bond with low price volatility still carry risk?
","sortOrder":3,"readingMinutes":5,"difficulty":"Básico"},"next":null,"pathContext":null,"curatedLinks":{"prerequisite":[],"continuation":[],"related":[]},"relatedConcepts":[{"concept":{"id":15,"slug":"time-horizon","term":"Time horizon","shortDefinition":"The period of time during which an investor plans to hold an investment before needing to get the money back.","longDefinition":"Time horizon is how long an investor can afford to hold an investment without needing the money sooner. It doesn't change an asset's intrinsic risk, but it does change the correct way to manage it: a long horizon gives more room for short-term swings (volatility) to even out over time, while a short horizon forces you to accept whatever result exists at the moment you need the money. That's why the same investment can be reasonable for a long horizon and risky for a short one, without the asset itself having changed."}}]}