These three words are often used interchangeably, but they describe different things. Confusing them leads to poor decisions. Understanding them leads to calmer ones.
This article explains the distinctions: volatility as normal movement, risk as the possibility of permanent loss, and uncertainty as the condition of not knowing. Getting clear on these terms is one of the most useful things a new investor can do.
This is general educational information, not personal financial advice.
Volatility: Movement, Not Danger#
Volatility refers to how much the price of an investment moves up and down over time. A volatile asset is one whose price changes frequently and sometimes dramatically. A stable asset is one whose price changes slowly and within a narrow range.
Volatility is often treated as a proxy for risk. It is not the same thing.
A share that falls 20% in a month and then recovers over the following year has been volatile, but no permanent damage has occurred. The investor who held through the decline ends up where they started (or better). The investor who sold during the decline locked in a loss that did not need to be permanent.
Volatility is what you feel. It is the discomfort of watching a number change. It tests patience and emotional discipline. But it does not, by itself, destroy value.
Drawdown vs Impairment#
A useful distinction: drawdown is temporary; impairment is permanent.
Drawdown is a decline from a recent high point. If an investment was worth $100, falls to $75, and later recovers to $110, the $25 drop was a drawdown. It was real at the time, but it did not represent a permanent loss of capital.
Impairment (or permanent capital loss) is when value is destroyed and does not come back. A company that goes bankrupt wipes out shareholders. A business that loses its competitive position may never recover its previous valuation. An investor who sells during a drawdown and never re-enters has converted a temporary decline into a permanent one.
The difference between these two outcomes often depends on what the investor does. Markets recover from drawdowns. Individual companies sometimes do not. And investors who panic during volatility can turn recoverable situations into unrecoverable ones.
Risk: The Possibility of Permanent Loss#
Risk, in the most meaningful sense, is the probability that something goes permanently wrong.
This is different from volatility. Volatility is noise. Risk is signal. Volatility tells you how bumpy the ride is. Risk tells you whether you might not arrive at all.
Several factors increase the risk of permanent loss:
Business failure. A company that cannot sustain its operations, loses its market, or becomes obsolete may never recover. Owning shares in a failing business is not just volatile. It is risky.
Overpaying. Even a good business can be a bad investment if purchased at too high a price. If the valuation assumes growth that never materialises, the loss may never be recovered.
Leverage. Borrowing to invest magnifies both gains and losses. In a severe decline, leverage can force a sale at the worst time, converting temporary drawdown into permanent impairment.
Forced selling. Needing to sell during a downturn, whether due to margin calls, liquidity needs, or panic, is one of the most common paths to permanent loss. The asset may have recovered, but the investor was no longer holding it.
Concentration. Betting heavily on a single company, sector, or outcome increases the chance that one bad event causes irreversible damage.
None of these risks are visible in short-term price movements. Volatility is easy to see. Risk is often hidden until it is too late.
Uncertainty: The Condition of Not Knowing#
Uncertainty is the background against which all investing takes place. It is not a specific risk. It is the acknowledgment that the future is unknowable.
No one knows what markets will do next year. No one knows which companies will succeed over the next decade. No one knows when the next recession will arrive or how long it will last. Models can estimate probabilities, but they cannot eliminate uncertainty.
Accepting uncertainty is not pessimism. It is realism. The investor who expects certainty will be constantly surprised and often panicked. The investor who expects uncertainty builds systems that account for it.
This is why process matters more than prediction. A good process assumes that some investments will underperform, that some years will be bad, and that surprises will happen. It does not require knowing which surprises or when.
Why This Distinction Matters#
Confusing volatility with risk leads to two common mistakes:
Selling during volatility. If a temporary decline is interpreted as permanent danger, the instinct is to flee. But selling during a drawdown often locks in losses that would otherwise have recovered. The market's short-term movements are not signals about long-term value.
Ignoring real risk. Conversely, a stable-looking investment may carry hidden dangers: poor fundamentals, excessive debt, or concentration in a fragile sector. Low volatility does not mean low risk. Some of the most damaging losses come from assets that appeared calm until they collapsed.
The goal is to tolerate volatility while avoiding genuine risk. This requires understanding the difference.
A Comprehension Check#
Before moving on, consider these questions:
- Can an investment be volatile but not risky? (Yes. If it fluctuates but recovers, volatility is not the same as permanent loss.)
- Can an investment appear stable but actually be risky? (Yes. Hidden problems do not show up in price movements until they become crises.)
- What turns a drawdown into a permanent loss? (Selling during the decline, or holding an asset that genuinely impairs.)
- Why does diversification help? (It reduces the chance that one failure causes irreversible damage, even if it does not prevent all declines.)
If these answers feel clear, the distinction is landing. If they feel uncertain, it is worth revisiting the sections above.
Summary#
Volatility is movement. Risk is the possibility of permanent loss. Uncertainty is the condition of not knowing the future. Volatility is visible and often uncomfortable, but it does not destroy value by itself. Risk is often hidden, lurking in business fundamentals, leverage, concentration, or forced selling. Uncertainty is permanent and cannot be eliminated, only acknowledged. The investor who understands these distinctions is less likely to panic during drawdowns and more likely to recognise genuine danger before it arrives.
Sources#
- Howard Marks. (2011). The Most Important Thing: Uncommon Sense for the Thoughtful Investor. Columbia University Press. (Foundational discussion of risk vs volatility)
- Taleb, N. N. (2007). The Black Swan: The Impact of the Highly Improbable. Random House. (On uncertainty and tail risk)