Controlling VolatilitySubmitted by Sound Financial Planning, Inc on December 6th, 2018
Would you like to lower the volatility of your investment portfolio? There’s an easy solution.
No, the solution we’re thinking of is not to retreat to cash—which, even in times of low inflation, is a strategy doomed to steadily lose the buying power of your portfolio. All that does is guarantee a downside.
Diversification will only get you so far. Downside risk doesn't go away just because you’re holding multiple asset classes, as everyone learned all over again in 2008-9.
The actual answer is: look at your portfolio less often.
Come again? Volatility is actually a time-based concept. Your portfolio goes up or down literally several times a second during every day, and of course, you would go crazy if you watched it second-by-second. So maybe instead you check daily. But why daily? Why not monthly? Or, since you know it’s a bad idea to sell out when the markets go down, why tempt fate and look even that often?
A recent report looked at monthly historical returns data for four combinations of global stocks and bonds going all the way back to January of 1926, up until December 2017: 30/70, 50/50, 70/30 and 100/0. The portfolios were rebalanced back to their original asset mixes every year, and 1% a year in management fees were taken out. The result shows what kind of volatility you would have experienced if you had looked just once a month, once a year, once every five years or once every ten years.
Across all four portfolios, if you looked at all of them once a month, you would see a negative return about once every three months. If you looked once every 12 months, you would only see a negative return about every 6 years. And if you only looked once every 5 years, about 90% of the time you’d see a positive return. That is, 9 out of ten times, your portfolio’s value would have been higher than the last time you checked.
And if you only looked once every ten years, pretty much every time, for all the portfolios, you would see a positive return. (Just once, the 100/0 portfolio showed a small negative performance number.)
Can you do this? Well, you don’t check on the value of your house every day, week, month or even year, do you? The value of your house may well be fluctuating wildly every week, but you’re blissfully unaware of this because you’re not getting a weekly appraisal. Chances are, your experience with this valuable and important investment is that when it comes time to sell, after multiple years of ownership, the value is greater than what you paid for it. It seems like no volatility at all.
The point here is: once you have the right investments and the right mix of investments, there really isn’t any point in checking in on your performance in the short term. You have a professional to do that—and chances are the professional won’t be acting on short-term information either.
WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES