Less risk, same return? Yes... it's possible
Investing in the stock market often brings to mind images of high-risk, high-reward scenarios—where fortunes are made and lost in the blink of an eye. This has led many to believe the stock market is much like a casino, where the odds are stacked against the player.
However, what if I told you that you could achieve market-like returns, or even better, with less stress and lower risk? This is possible by investing in a properly diversified portfolio strategy with 75% of the market's volatility.
Understanding Volatility and Its Impact
Volatility refers to the degree of variation in the price of an asset over time. The stock market is known for its volatility, with prices often swinging wildly based on economic data, company performance, and investor sentiment. While this volatility can lead to substantial gains, it also brings the risk of significant losses.
A portfolio that is designed to have 75% of the market's volatility is one that is less sensitive to these market fluctuations. This lower volatility can be achieved by diversifying investments across different asset classes, including bonds, real estate, and low-volatility stocks.
The Power of Compounding Returns
One of the key reasons why a lower-volatility portfolio can match or even outperform the market over the long term is the power of compounding. When you experience less severe drawdowns during market downturns, your portfolio has less ground to make up during the recovery phases.
For instance, a 50% loss requires a 100% gain to break even, while a 25% loss only requires a 33% gain. A low-volatility portfolio can maintain a steadier growth trajectory by reducing the severity of losses.
Over time, this steady growth can compound to produce returns comparable to or exceeding the broader market.
Behavioral Advantages of Low Volatility
Another advantage of a low-volatility portfolio is the psychological comfort it provides. Market downturns can be stressful, leading many investors to panic and sell at the worst possible times.
A portfolio with reduced volatility experiences smaller swings, which can help investors stay the course during turbulent times. This behavioral advantage can result in better long-term performance, as staying invested is crucial to capturing the full benefits of market growth.
Historical Performance of Low-Volatility Strategies
Historical data supports the idea that low-volatility strategies can deliver competitive returns. Numerous studies have shown that portfolios with lower volatility tend to produce similar or better risk-adjusted returns compared to more volatile portfolios.
For example, low-volatility stocks have often outperformed their high-volatility counterparts over long periods despite having lower risk.
This phenomenon, known as the "low-volatility anomaly," challenges the traditional notion that higher risk leads to higher returns. Instead, it suggests that a more measured approach to risk can be just as rewarding.
Building a Low-Volatility Portfolio
Creating a portfolio with 75% of the market's volatility involves careful selection of assets. Here are some strategies to consider:
- Diversification: Spread your investments across various asset classes, such as bonds, real estate, and equities from different sectors and regions. This helps reduce the impact of any single market event on your portfolio.
- Low-Volatility Stocks: Invest in companies with stable earnings, strong balance sheets, and less sensitivity to economic cycles. These stocks tend to be less volatile and provide steady returns.
- Fixed-Income Investments: Incorporate bonds and other fixed-income securities, which are generally less volatile than stocks and provide a buffer against market downturns.
- Alternative Investments: Consider adding alternative assets like real estate, commodities, or hedge funds, which can provide additional diversification and reduce overall portfolio volatility.
The Case for Low Volatility
Investing in a portfolio with 75% of the market's volatility is not about avoiding risk altogether—it's about managing it effectively. By reducing volatility, you can achieve a smoother ride with similar or superior long-term returns. This approach allows you to benefit from the market's growth while minimizing the emotional and financial toll of severe market swings.
Ultimately, it's not just about how much your portfolio grows but also about how consistently it grows. And a low-volatility strategy could be your key to achieving financial goals with less stress and more confidence.
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Matt Faubion, CFP®
Founder - Wealth Manager