How volatility destroys your portfolio

Markets started the year on an extremely turbulent note with most global equity indices swinging widely between losses and gains on the back of rising uncertainties about the global interest rate path and geopolitics.

 

Generally, some volatility in markets is healthy as it reflects price discovery processes at play. It also creates opportunities for traders. However, too much volatility can destroy value.

 

Our chart of the week below which shows the performance of three hypothetical portfolios with varying levels of volatility illustrates why volatility is often regarded as the investor’s biggest enemy. Over time a low volatility portfolio (standard deviation of 7.5%) which never grows by more than 10% but never loses more than 5% significantly outperforms a medium volatility portfolio (standard deviation of 27.5%) and a high volatility portfolio (standard deviation of 38%) which grow 25% and 40% and lose 20% and 35% respectively.

 

The surest way for softening the impact of volatility on one’s assets is to have a well-diversified portfolio. Alternatively, investors can invest in low-volatility portfolios.