What is volatility?

This question was raised within the 1996 annual report for American Funds‘ SMALLCAP World mutual fund and accompanied by the following Ibbotson Associates chart:

Volatility is in the eye of the beholder

The report goes on to state: “Most people instinctively know that volatility and risk are related. But they’re not synonymous. Volatility refers to the amount of fluctuation–both up and down–that an investment may experience. Risk is the perceived possibility of loss (or the perceived loss of purchasing power to inflation). … The charts above are an attempt to show that olatility, like risk, is in the eye of the beholder. Each uses the same data to illustrate what happened to small company stocks between the years of 1973 and 1982. The first chart (which we tend to think reflects how most people view their investments) traces the month-by-month percentage return. The second plots the cummulative effects of those monthly returns on the value of a $10,000 investment. The third shows the cummulative annual change in value of that same investment, illustrating how short-term fluctuations generally smooth out over time.”

I’ve always appreciated this chart’s visual reminder to perspective when investing, but lately, it’s caused me to think about its applicability to my profession of software development in a number of ways as follows:

  • What kind of environment is set by executives, line management and architects like me to those in the trenches? How are decisions perceived once conveyed?
  • In the context of mentoring and contributing to annual performance reviews of staff, how does the day-to-day translate into a curve of career development (or decline)?
  • What are the equivalents of volatility and risk in software development for my superiors, for me and for my subordinates?
  • Are context switches–the bane of most developers–about risk, volatility, or both?

How would you answer these questions? What connections, if any, can you draw here?