You might want lower volatility in your ASX share portfolio, but it almost always comes at a cost. Understanding this is vital.
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If you asked a group of ASX investors what their ideal portfolio would look like, I’d bet that some would answer ‘high growth with low volatility‘. This is especially the case when it comes to a superannuation account. This is understandable to an extent. None of us truly enjoy watching the value of our ASX share portfolios bounce around, or crater. For many readers, the memories of what was happening this time last year might still be fresh. That was a scary time indeed.
But low volatility is not something that can be achieved with regularity. Or I should say with regularity without giving up growth opportunities.
Modern portfolio theory, a classic framework for analysing investments that won its creators a Nobel prize, is very clear on this. If you want higher growth, it walks hand in hand with higher volatility. Now, modern portfolio theory has its critics. May investors, like Warren Buffett for instance, don’t agree with all of its teachings. But it does have a point here. Assets that inherently deliver low volatility also usually deliver low growth. Think about it, the appeal of holding cash is its absence of volatility. That’s why many investors try to convert their shares to cash in a market crash.
Volatility and your ASX share portfolio
There are two main ways investors try and reduce volatility in their portfolios. The first is to do exactly what we just talked about – convert volatile assets to cash when volatility emerges.
But that strategy for avoiding volatility is fraught with danger. Remember, we only know the market is crashing when the crash itself has already begun. Because of this, converting your shares to cash in order to avoid volatility usually results in ‘locking in’ a loss on your investment. You then have to time the recovery again to get back in, potentially locking yourself out of a rising market. This rarely works, and almost never does consistently. That’s why there’s that phrase ‘time in the market beats timing the market’.
The second way investors try and beat volatility is by holding assets that are believed to be less volatile in the first place. It could be an exchange-traded fund (ETF) that holds bonds or cash. It could be infrastructure companies, consumer staples businesses, or other investments like gold that investors consider ‘defensive’. However, these investments are usually not market-beating performers over the long-term. That’s partly why they are called ‘defensive’ in the first place.
And we are back where we started: If you want lower volatility, you have to give up the prospects of higher growth.
Most successful investors, like Warren Buffett, have accepted that volatility is a part of this success. Think about it, anyone who held their nerve in the market crash last year and didn’t touch their portfolio has probably come out the other side stronger than ever. And volatility also gives us the chance to buy our favourite ASX shares at cheap prices. Volatility can be scary, but it can also be our friend if we let it.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.