Know thy REAL enemy: INFLATION (not Volatility)

Amit Trivedi has an interesting article on the topic at moneycontrol:

If a financial plan is carefully drafted, one must adhere to that unless proven that it is a completely wrong plan or that the initial assumptions were wrong. However, often people tend to change their financial plan in light of adverse short term price movements, without giving a thought as to what inflation can do to their future finances. At the same time, people have also changed the allocation to the riskier assets looking at the recent short term superior performance.

Any investor would be better off understanding the two prime risks of investments – volatility and inflation. Volatility of prices is the short term risk – inflation is long term risk. An investment plan must be made keeping these two risks in mind.

Inflation does not affect one much in the short term as the prices of essential commodities do not rise too much in short period, normally. Because of this, we tend to take inflation very lightly and ignore it while planning for our long term goals. Volatility on the other hand is an immediate risk as the prices of various securities fluctuate in the short run. This is the difference between the two risks – the former being almost invisible in the short run whereas the latter being magnified by the discussions around it. We tend to, then, overweight volatility and underweight inflation.