Volatility Final

One of my passions in life is trying to take complex issues and boil them down to their essence in a simple, but not simplistic, way. This goal is something that I’ve found most of us in the advice industry struggle with and is in fact the reason the behavior gap exists. The traditional financial services industry is a place where things are overly complex and almost always confusing to clients. Almost everything we do with clients is intangible, and most of our clients don’t understand half of what we say. Despite our best efforts, we’re almost always using industry jargon.

Client relationships are often challenged by this idea of complexity and confusion. One of my goals at Behavior Gap is to capture the collective wisdom and experience of people who have given money advice for years and do it in a way that represents the simplicity on the other side of complexity. There is a big difference between ignorance and simplicity. When done right, simplicity captures the true purpose of a concept. As Leonardo Da Vinci puts it, “Simplicity is the ultimate sophistication.”

One of the things I’ve thought a lot about is how we discuss risk. The complex version of the risk conversation revolves around standard deviations and volatility. Just try to find two words that real people in the everyday world understand less. Even if you’re required to take a statistics class in school, how hard did you try to remember what learned after the class was finished?

For most people, standard deviation was a term they never believed would apply outside the classroom and didn’t expect to hear about it again. But here we are trying to help clients make some of the most important decisions of their lives about investing their money, and we’re using words like standard deviation and volatility to explain their risk. To put it into perspective, I found myself thinking one day about how my mother thinks and talks about risk. I know my mother does not wake up in the middle of the night worried about her volatility. Nor does she spend time discussing with her friends how stressed she is because her standard deviation is too high. I believe, like my mom, that most non-money people don’t use these complex terms to describe how they feel about risk.

So what does risk mean in real terms when we’re talking about a broadly diversified portfolio? Fluctuation. That conclusion led to the above sketch. Volatility, standard deviation, risk, fluctuation—they’re really just another way of saying how much something wiggles. We could spend days discussing risk, but if you use fluctuation as the simple explanation for risk, then stocks wiggle more than bonds and bonds wiggle more than cash when we’re referencing a diversified portfolio. This fluctuation, or wiggle, is what we’re really describing when we try to help people understand and accept the risk when they invest in equity markets.

The goal of this sketch was to create a tool to help people understand in a simple way a very complex concept. What you are doing to get to the simplicity on the other side of complexity? If you’re in the advice business, I hope it helps you have better conversations with clients. I know I’m not the only one looking for ways to better explain this complex ideas, so I’d love to hear how you’re describing risk to clients.

This sketch and post originally appeared in the Behavior Gap Newsletter. Sign up for your FREE subscription.