CHICAGO, August 2 (Reuters) – Most experienced long-term
investors know stocks are volatile and can deal with it. But
what if you want to stay in stocks and at the same time reduce
your downside risk and avoid a cyclonic year like 2008?
You might be tempted by funds that bill themselves in a “low
volatility” category, though “volatility” is a red herring. A
“low-beta” approach might be better.
Beta is a measure that portfolio managers use to determine a
portfolio’s sensitivity to a major index. A perfect match with
the index is 1.00, and stocks are measured in a percentage
against it. The lower the beta, the less a portfolio tracks a
market average, such as the S&P 500 index.
From 1926-2011, according to Ibbotson Associates,
large-company stocks had a standard-deviation of about 20
percent. Small-company stocks were much more volatile over that
period: 32 percent. When you look at long-term government bonds,
though, volatility drops to 9.8 percent, and with a portfolio of
U.S. Treasury bills, it drops to 3.1 percent.
Keep in mind that I’m referring to historical volatility;
flash crashes and technical glitches such as the one that
occurred on We dnesday with Knight Capital are another
matter. Volatility is often unpredictable in a market
increasingly dominated by high-frequency robotic trading, which
often amps up market movements.