Three strategies to help you manage volatility
Equity investors looking to limit volatility may want to consider dividend-paying stocks.
Managing an investment portfolio is a challenge. Recent market cycles have tested many investors' commitment to their long-term investment plans.
Understand that while volatility cannot be eliminated, it can potentially be reduced. The following three strategies can be used to help you reduce the amount of volatility in your portfolio.
Strategy 1: Seek investments with low correlation
Longer term, the market risk associated with an individual asset class, such as stocks, may be reduced by allocating a portion of a portfolio's assets to other types of investments that historically have reacted differently to market and economic events.Footnote 1 This is known as "correlation," which measures the tendency of two investments to move together. A correlation close to zero indicates that two investments are largely independent of each other. The closer a correlation is to 1.00, the greater the tendency two investments have had to move in tandem. The table below lists four assets that have had relatively low correlations with U.S. stocks during the past decade.Footnote 2 Past performance does not guarantee future results.
Assets with relatively low correlations compared to U.S. stocks during the past decade |
| |
Commodities |
Cash |
Investment-
grade bonds |
Home prices |
| Large-cap stocks |
0.59 |
-0.15 |
-0.12 |
-0.13 |
Strategy 2: Diversify your investmentsFootnote 1
Modern portfolio theory is founded on the assumption that investment markets do not reward investors for taking on risks that could be eliminated though diversification. There are many strategies available for diversifying a stock portfolio. Investors can allocate portions of a portfolio to domestic and international stocks, which may take turns outperforming depending on circumstances in various global economies.Footnote 3 An allocation to small-cap, midcap, and large-cap stocks also provides exposure to companies of various sizes. Although there are no guarantees, smaller companies may be nimble enough to exploit untapped market niches and capitalize on growth potential.Footnote 4
Strategy 3: Consider dividend-paying stocks
In addition, equity investors looking to limit volatility may want to consider dividend-paying stocks. Although a company can potentially eliminate or reduce dividends at any time, a dividend may provide something in the way of a return even when stock prices are volatile. When evaluating dividend-paying stocks, it may be worthwhile to review how long a company has paid a dividend and whether the dividend has increased over time. Firms that had increased their dividends for the past 25 years outperformed the S&P 500 and also were less volatile during the period from 1990 to December 31, 2020.Footnote 5 Past performance does not guarantee future results.
For investors interested in managing volatility, low-correlation investments, diversification, and dividend-paying stocks may be worth considering.
Footnote 1 Asset allocation and diversification do not ensure a profit or protect against a loss in declining markets.
Footnote 2 Source: SS&C Technologies, Inc. Large-cap stocks are represented by the S&P 500 Index, commodities by the Standard & Poor's GSCI
®, cash by the Bloomberg Barclays U.S. Treasury Bill 1-3 Month Index, investment-grade bonds by the Bloomberg Barclays U.S. Aggregate Bond Index, home prices by the S&P/Case-Shiller 20-City Composite Home Price Index. You cannot invest directly in an index. Past performance is not a guarantee of future results. Data is based on the 10-year period ending December 31, 2020.
Footnote 3 Foreign stocks involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, and may not be suitable for all investors.
Footnote 4 Securities of smaller companies may be more volatile than those of larger companies. The illiquidity of the small-cap market may adversely affect the value of these investments.
Footnote 5 Source: SS&C Technologies, Inc. Returns are based on the S&P 500 Dividends Aristocrats. Volatility is measured by a statistic known as standard deviation. Past performance does not guarantee future results.
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The material was authored by a third party, DST Retirement Solutions, LLC, an SS&C company ("SS&C"), not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.
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