Tag Archives: risk

How do I reduce investment volatility?

Image by Unsplash

By Steve Lowrie, CFA

Special to the Financial Independence Hub

I must admit, the title of today’s post is a bit bogus.  How so?  Not to split hairs, but “volatility” is the variance above and below a long-term trend line. The thing is, nobody has ever asked me whether I can help them reduce their upside volatility.  When equity markets are returning above-average returns, everyone’s happy.

So, I believe the actual question behind the question is how to reduce downside volatility.  There are many kinds of investors, but I’ve never met anyone who enjoys seeing their investments go down, sometimes in a hurry.

From the behavioural side of things, it’s best to treat periods of downside volatility as bumps in the road, rather than turning them into permanent losses by bailing out when they occur. In that context, how do you best reduce investment volatility? There are at least two possibilities to explore.

1.)    Reducing volatility through asset allocation

Understanding the role volatility plays in efficient markets circles us back to an investment strategy I’ve suggested all along:  globally diversified asset allocation.

Instead of trying to manage volatility by trying to time markets or by selecting certain types of securities, I would suggest the better tool for the job – in fact the best one – is a healthy exposure to high-quality bonds.  A bond allocation tempers your portfolio’s overall volatility.  Once you have established that, you can then optimize your equity portfolio by tilting toward equity market factors with sources of higher expected returns (such as size, value and profitability).

2.)    Reducing volatility by selecting low-volatility/low-beta stocks 

Certainly, there are those who claim they can capture the returns of the broad equity markets while offering a smoother ride.  The vast majority of these strategies fall into the categories of “low-volatility,” “equity minimum-risk” or “minimum variance.”  They have been around for decades, and their popularity ebbs and flows with the market’s gyrations.

Gut feel would suggest that if you want to lower the volatility of your equities, it might make sense to focus on stocks that have exhibited lower volatility than the overall market (“low-beta stocks” in industry jargon).  Perhaps yes, but the practical questions are whether these strategies (a) actually work, and (b) work better than asset allocation, as described above.

Before diving into the evidence, we’ve known for decades that market risks and expected rewards have been highly correlated around the world.  In other words, lower risk/lower volatility stocks tend to be the same ones that deliver the lowest expected returns.  So, just based on intuition, a “free lunch” of more market returns with less risk may not be so “free” or easy to obtain. It seems more likely lower volatility will simply lead to lower returns.

What the evidence tells us about low-volatility investing

Looking at an abundance of evidence, financial author Larry Swedroe has published several excellent, although highly technical articles about low-volatility/low-beta investing.  In this one, he explains that researchers documented a “low-beta anomaly” decades ago. But he notes: Continue Reading…

Challenging conventional investment wisdom

By Noah Solomon

Special to the Financial Independence Hub

Many investment professionals tell their clients:

  • That markets tend to rise over the long-term.
  • To “hang in there” and “sit tight” during bear markets because they will eventually recover their losses.

While we agree with the first assertion, we wholeheartedly disagree that investors should sit idly through bear markets based on the notion that they will eventually live to see a better day. Rather, we strongly believe that a dynamic approach that adjusts to changing markets can provide superior long-term results.

The table below illustrates this by showing what happens to $1M invested in two different portfolios:

Portfolio A Portfolio B
Year 1 -30% -5%
Year 2 +30% +5%
Year 3 -30% -5%
Year 4 +30% +5%
Sum of returns 0% 0%
Value at end of year 4 $828,100 $995,006


Since the returns over four years add up to 0% for both portfolios, many people assume that the final value of each portfolio at the end of year 4 should be $1 million. However, as the last line in the table indicates, this is far from true.

Portfolio A, which is more volatile, declines in value by $171,900, while portfolio B, which is less volatile, suffers a decline of only $4,994.

The observation that two portfolios can have the same sum of returns over 4 years yet have significantly different values at the end of the period can be explained by the mechanics of compounding. After experiencing a 30% loss, a $1 million portfolio is worth only $700,000. Unfortunately, a subsequent 30% gain will only bring the value of the portfolio back to $910,000, which is still $90,000 less that its starting value. However, when a $1 million portfolio experiences a 5% loss, its value is $950,000, and a subsequent gain of 5% will bring its value up to $997,500, which is only $2,500 less than its starting point. Continue Reading…

Searching for yield without reaching for risk


By Kevin Flanagan, WisdomTree Investments

Special to the Financial Independence Hub

What do almost all major global bond markets have in common thus far in 2019? You guessed it: lower rates. As a result, investors have returned to an environment that could be characterized as “yield challenged” and one that had become all too familiar before last year’s run-up in rates.

Typically, the search for yield comes with added risks as investors either move too far out in duration or lower their credit quality constraints. But what if an investor could enhance yield in their fixed income portfolio while maintaining familiar risk profiles?

Before we focus on a solution, let’s first garner some insights into the Canadian bond market. Similar to the situation south of the border, the Canadian rate outlook going into 2019 was not geared toward a lower rate setting. From a policy perspective, the Bank of Canada (BOC) was projected to continue on its rate hiking path. Prior to the December 2018 U.S. Federal Reserve meeting (the point when expectations began to reveal some change), the implied probability for a BOC rate hike by April was placed around 75% (for those interested, the figure for a rate cut was under 2%). Fast-forward to May 23, and the readings for a rate hike or cut by the end of October are almost split evenly at a little more than 20% each.

CAD 10-Year

CAD 10 Year

How about the Canadian government bond market? As the adjacent graph clearly illustrates, after the 10-Year yield peaked at 2.60% in early October last year, the trend to the downside has been unmistakable. Continue Reading…

If you must speculate in penny stocks, find those with these common characteristics

Penny stocks do sometimes pay off, but there are many pitfalls to avoid. As you’ve heard us say often, a lot of penny stocks are little more than very well executed marketing campaigns.

Take a look at the penny stocks in your portfolio. If you’re a penny stock investor you likely have a number of them. The top 10 penny stocks in your portfolio should follow these guidelines:

Tips for analyzing your top 10 penny stocks

  • Look for strong management: Look for an experienced management team with a proven ability to develop and finance a mine, product or service.
  • Look for a strong balance sheet: High-quality penny stocks should have strong balance sheets with low debt. It’s even better if they have a major financing partner.
  • Look for well-financed companies: To profit in penny stocks, you should look for well-financed companies with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.
  • Look past the hype: Avoid stocks that are trading at unsustainably high prices as a result of broker hype or investor mania.
  • Look for stocks trading on a well-regulated exchange: We think you should avoid stocks trading “over-the-counter”, where such things as regulatory reporting are lax. Stick to penny stocks trading on regulated exchanges like the Toronto and New York stock exchanges.
  • Look for a results-focused company: Automatically rule out investing in companies that promote themselves too aggressively, or do so misleadingly. Success is more likely if the managers focus on developing a saleable product or service, rather than hyping their story.
  • Look for reasonable share prices: Compare the market caps (the total dollar value of all of a company’s outstanding shares) of the stocks with the estimated value of their assets or future earnings streams. Only a few penny stocks will successfully launch a product with enough success to justify the current share price and avoid collapse.

Your top 10 penny stocks will not be marketing ploys

Many penny stocks are little more than very well executed marketing campaigns. Your top 10 penny stocks won’t fall into this category. Many penny stock promoters will do anything in their power to get their penny stock noticed. These extensive marketing campaigns include emails, TV interviews, podcasts, newsletters and paid sponsorships.

There are also some so-called news sites that will sell sponsorships to penny stock promoters. These are great opportunities for penny stock promoters but bad for investors looking for an unbiased opinion on a stock. Continue Reading…

Should you invest in pot stocks? How do you invest in the cannabis sector?

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