More Predictability & Less Volatility

Predictability refers to what degree the performance of an investment portfolio may be predicted.

To illustrate by providing two extreme cases, a perfectly predictable portfolio would be one that always provides exactly the same return in every time period, for example $100 per month in every month or $500 per year in every year. It would always yield exactly the same amount and would therefore be perfectly predictable.

At the opposite extreme, a portfolio with a very low degree of predictability would return widely varying amounts in every time period, maybe $1 one year, $1000 the next year, or some other unpredictable string of returns.

Thus, a more predictable investment is one in which an investor has a higher degree of certainty about the return that he or she will receive in a given time period.

Volatility is related to the concept of “risk”. It refers to the extent to which an investment may vary in price over a given period of time. For example, consider the following possible company stocks:

Both stocks have an average price over the week of $100. However, the stock price of Company 1 varies from a low of $50 to a high of $150, while the stock price of Company 2 has less variation in the price by day, with a low of $95 and a high of $105. We could say that the stock price of Company 2 is less volatile - it has a lower degree of variation in its price. The stock price of Company 1, on the other hand, changes a lot day by day - it has a higher degree of volatility.

The Roles of Predictability and Volatility in Investment

Predictability and volatility are, in a sense, inversely related - high volatility implies low predictability and vice versa. Ideally, a given portfolio provides high predictability and low volatility, because such a portfolio would better enable an investor to plan for the future as he or she would have a higher degree of confidence in the return at a given point in time.