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The joy of volatility

Volatility in the equity markets is the best possible thing for investors

The joy of volatility

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What is the opposite of fragile? That's a question that Nassim Nicholas Taleb always asks when he is talking about his book Antifragile. Audiences always respond with words like 'strong' or 'robust' or 'unbreakable'. Then Taleb asks, "What is the opposite of positive?" Obviously, people answer 'negative'. "Why didn't you say that the opposite of positive is zero? If the opposite of fragile is robust, then the opposite of positive should be zero. This usually needs further explanation from him.

If, as Taleb explains, you are shipping a glass object, you normally write 'Handle Carefully' on the package. However, if you are shipping something made of iron, you won't write anything on it, because an iron object is strong and robust and unlikely to break if the package is dropped. But that's not the true opposite of fragile. If your package contains something which is the opposite of fragile, then will you write on it, 'Please Mishandle'? If fragile things are those that are harmed by any kind of shock or adversity, then the opposite of fragile must be those things that actually benefit from shock or adversity.

After reading at first this logic seems absurd. While there are things that can resist shock, surely there can't be anything that will actually benefit from it! However, once Taleb starts explaining, and once you start thinking about what he says, you realise that there are many, many things that are complete opposite of fragile.

When we skim headlines about equity investing, we get the impression that volatility is absolutely the worst thing for investors. Like for the last few months or so, the stock markets have been quite volatile and anchors of business TV channels generally have long faces. The headline-writers always assume that since the equity markets are oscillating sharply, dropping on more days than they rise on, it's a bad time for investors. And surely, there must be investors for whom that is true. The crowds of punters whose success or failure depends on correctly predicting what will happen from one day to the next also suffers.

But is there any investment strategy that is available to the ordinary saver, which will bring in the gains of equity investing, and yet actually gain from volatility? Is there an antifragile investing strategy that you and I can use?

Of course there is, and it's something that smart mutual fund investors are already practicing. I am talking, of course, about SIP (Systematic Investment Plan). SIP is based on the idea of averaging your investment cost over time and it's the simplest and yet most effective technique of benefitting from volatility. You invest a constant amount every month and keep doing it for a long time. When the markets drop, stock prices are low and so are the NAVs of equity mutual funds. Therefore, the sum you invest gets you more units of the fund. Eventually, when you redeem your money, all units fetch you an equal amount. However, your gains are higher because of the volatile periods, when you were able to invest at a low price. That's antifragile--actual benefit from volatility.

SIP gains depend on the long-term, gradual rise in equity prices, punctuated by periods when the markets are volatile or it drops. It's a supremely antifragile investing strategy. You make more money precisely because markets are volatile. If, hypothetically (it never actually happens), the equity markets rose by a constant amount every day, then there would be no advantage in SIP investing.

SIPs are essentially a psychological trick to keep investing regularly, regardless of whether the markets are up or down. It's the routine that locks investors into an inertia which turns out to be of benefit to them. The antifragile nature is a hidden advantage that proves beneficial over time.

When one looks at investing with this fragile-antifragile mind frame, it is immediately obvious that short-term trading of equities (or derivatives) is the ultimate in fragility and long-term SIPs is the ultimate in antifragility.