What’s an investor to do about rising volatility? For many investors, the answer is, not much. Ideally, one wants to be in the market on the up days and out on the down days. In reality, no one can call those days accurately in advance. Academic studies have shown that most of the gains in the stock market occur on just a few trading days. The risk of being out of the market on good days outweighs the reward of avoiding the losers and the transaction costs of managing the process.
To avoid the extremes of one asset class or another, one needs to employ an asset allocation strategy for smoothing portfolio performance. Diversification may help moderate the impact of exceptional days.
Here are the returns for various mixes of stocks and bonds in the five year period 2011-2015.
|Year||100% Large Cap Stocks||70% Stocks, 30% Bonds||30% Stocks, 70% Bonds||100% Bonds|
* Stocks are represented by the Standard & Poor’s 500 Index. Bonds are represented by the Barclays Capital U.S. Aggregate Bond Index. Past performance does not guarantee future results.
The bond market doesn’t always move in lockstep with the stock market, so an allocation to this asset class also may reduce the impact of daily swings.
All investing involves risk, but risk shouldn’t keep anyone from investing. Successful investors learn how to manage their risk by finding a comfortable balance between the risks that they are willing to take and the rewards appropriate with those risks.