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Your Personal Finance Questions - Answered!

“What investments can I add to my portfolio that will reduce its overall volatility"

The topics this week will focus on the recent volatility in the stock market, and what you can do to help reduce the effect that a tough week in the stock market can have on your portfolio.

Today’s question is:

“What investments can I add to my portfolio that will reduce the overall volatility of my portfolio?”



Transcript

We are not going to get into different ways to measure and calculate volatility, but for this we are going to use standard deviation. And what you need to know is that a lower standard deviation means lower volatility in the prices.

So as a baseline here - Since 1995, a portfolio made up of solely US stocks has a standard deviation of 14.7.

We backtested tons of different asset classes with a 50/50 split with US stocks, and the asset that resulted in the largest reduction in volatility was a total US bond fund.

The most popular total bond fund today is an ETF with ticker symbol AGG and we use a fund with ticker symbol SPAB for our clients at Hylland Capital

A portfolio of 50/50 US stock and a total bond fund had a standard deviation of 7.4, effectively cutting the portfolios volatility in half

Another great option was a 50/50 split of long term treasuries, which had a standard deviation of 7.9.

A 50/50 split with US stocks and gold had a standard deviation of 11.

But I think it is important to know that over the last 28 years, reducing volatility has also meant reducing returns. A portfolio made up of 100 percent US stocks has returned 10.1% per year on average. A portfolio split between US stocks and a total bond fund delivered 7.7 percent.

That means a $10,000 investment in 100% US stocks in 1995 is worth $100,000 today, while an investment that was 50/50 between US stocks and a total bond fund is worth $65,000.

So, if you are young and have plenty of time to stay invested in the market, the best course of action may be one that helps you deal with volatility, instead of reducing it.

 

Matt Hylland