A quick examination of why so many investors ignore portfolio volatility at their peril.
Today’s Investment Reality Means Volatility
I have conversations with a number of investors from across Canada almost daily. It is very interesting to get a sense of the common threads running through people’s minds. Many seem to think that Alberta is about to disappear due to the recent oil price decline. Yes there has been a downturn, but there is still plenty of activity, and in fact opportunities often present themselves during downturns. Many of you probably own Canadian stocks, are resource-heavy, and this has caused some investment portfolios to be devastated as well. The root cause of the issue is volatility which is caused by concentrating assets into a single asset class or sector. To me, the most interesting thing about this is the fact that not a single investor, in the past 23 years, has ever started a conversation with me by saying “Can you help me control my portfolio volatility?” I will show you why this is a huge mistake, potentially costing you a huge chunk of money, below.
The Flip Side
Regular conversations with professional institutional-quality investors take on a completely different tone. For example, I was speaking with a representative from a successful Canadian portfolio management service the other day, and the entire conversation was focused on how we can construct a portfolio to reduce volatility. I am always exploring the most efficient ways to generate returns with the lowest amount of downside risk possible. How can we combine public stocks, bonds, ETFs, hedge funds, portfolio managers, and private opportunities to accomplish investor goals in the most effective manner? How do assets such as private farmland and precious metals possibly play a role?
Here is Why We Do It
Take a look at the chart below. Shown are two hypothetical ways to, starting with $1 Million, generate an 80% return over 10 years:
- The blue line shows a steady 8% compound return annually for an 80% total return
- The black line shows the same 80% return but with high volatility introduced into the example
Steady returns of 8% per year, over 10 years, add up to more than $2.1 Million. Generating the same total return, with stock market-like volatility, adds up to only $1.7 Million. This example shows volatility reducing your overall results by approximately $400,000 over only 10 years! How important is 400K to you?
Now we can clearly see why a major aspect of our portfolio thought process should be reducing volatility and not necessarily generating the highest return. It simply means more money in your account, with less risk, which is better!
Volatility of The Financial System is Hurting Us
Why do so few investors seem to care about volatility, even though controlling it is one of the most obvious ways to accomplish retirement needs, and avoid the shocks of the volatility roller coaster? It is because the vast majority of the financial system is designed to collect your money, buy traditional investments, and charge a regular fee. Your bank, mutual fund, and brokerage firm might be preaching “long term, balanced-portfolio” so often that it becomes of collective consciousness. They tell you that you just have to grin and bear it, even though in reality it is stressing you out, and the only ones who seem to profit are the institutions.
Once you start to discover the investment methods used by the world’s top investors such as super-endowments, you realize that not only do they approach investing differently, but their results have been extremely efficient. Seeking low volatility can come with additional risks, such as limited liquidity, that you should be aware of. Nonetheless, information about your alternatives is an empowering way to make sure that your investments are profiting you, not a third party. A great start would be a publication put together by Brookfield Asset Management which can be found here. Plus you can watch my presentation “Smarter Than Bay Street: What the Wealthy Do Differently” which discusses how you can apply these concepts to your situation by clicking here