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After the stomach-churning market drop of several years ago and the equally impressive climb back from 2009's lows, many investors are feeling a bit exhausted. After all, how much whipsawing back and forth can folks take? Judging by the way investors have abandoned stocks in recent years, the answer may be "not as much as we thought." And while keeping your eyes on the long-term picture will help keep shorter-term events in perspective, there are a few adjustments you can make within your portfolio that may help ease those temporary bumps in the road.
Smoothing the bumps
Investors who are sick of the equity market's roller-coaster ride have some new tools to help manage volatility in their portfolios. In recent years, a number of "low-volatility" exchange-traded funds have been introduced. These funds focus on stocks that tend not to experience wide price swings but that exhibit more stable price behavior over time. For instance, the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEMKT: SPLV ) tracks the performance of the 100 least volatile stocks in the S&P 500 Index over the prior 12 months (as measured by standard deviation). These stocks are weighted by volatility, with the more volatile names getting a smaller weighting in the portfolio. This ETF has a reasonable 0.25% expense ratio and is a decent choice for folks who want exposure to lower-risk stocks.
Besides the benefit of avoiding hefty market drops, there is some evidence that lower-volatility stocks may have a slight return advantage. A study in the Journal of Portfolio Management found that from 1968 through 2005, among a universe of 1,000 stocks, the least volatile constituents had a 1% greater annualized return and 25% less volatility than that of the entire sample group. But if you don't want to buy an ETF like the PowerShares fund mentioned above or any of the other dedicated low-volatility ETFs on the market, there are other options, including some funds you may already own.
Stability and yield
Vanguard Dividend Growth (VDIGX) is a study in moderation and stability, making it an excellent choice for investors who want to dampen volatility as well as capture some extra yield. Manager Don Kilbride of Wellington Management looks for companies with long histories of generating ample cash flows that can fund rising dividend payouts. The resulting portfolio tends to focus on top-quality blue-chip names like Johnson & Johnson (NYSE: JNJ ) and Microsoft (NASDAQ: MSFT ) , which earned a spot in the portfolio thanks to their strong balance sheets, reliable cash flows, and above-average returns on equity.
Because the average company in the portfolio tends to have a more stable financial profile, volatility is kept in check here. Over the past decade, Vanguard Dividend Growth has measured in with a standard deviation of 12.2, compared with 14.8 for the S&P 500 Index and 15.5 for the average large-cap blend fund. The lower a fund's standard deviation, the less variation in returns (or lower volatility) it experiences. With a low 0.31% price point and a 10-year annualized return that puts it in the top 5% of its peer group, Vanguard Dividend Growth is a fine choice for investors who want high-quality stocks without a lot of volatility.
Another fund that offers a relatively bump-free ride is American Funds American Mutual (AMRMX). Just keep in mind that this fund charges a front-end load, so only purchase it if you can do so without paying this fee, probably in an employer-sponsored retirement plan such as a 401(k). This fund is split up into several "sleeves," with a different manager running each portion. The focus here is on financially stable, industry-leading companies with a solid history of making dividend payments. As with Vanguard Dividend Growth, such an approach lends itself to a more stable portfolio, devoid of wide price swings. American Mutual's 10-year standard deviation is just 12.1, indicating a relatively steady ride, at least compared with its peers.
Top holdings in the portfolio include Amgen (NASDAQ: AMGN ) , which fund management believes has matured into a first-rate biotech with a demonstrated commitment to growing its dividend. Likewise, retailer Home Depot (NYSE: HD ) has benefited from the rebound in the domestic housing market and should continue to see increased profit margins from a recent inventory management system overhaul. With more than $25 billion in net assets, this fund is a hefty one, but its focus on the larger end of the market cap spectrum means it shouldn't be boxed in by its asset load.
While low-volatility funds like these can help smooth out your portfolio's trajectory over time, investors should be aware that these investments are not a sure thing. Low volatility doesn't mean you're guaranteed against losses. And keep in mind that low-volatility investing can be decidedly out-of-favor when the market takes off. In fact, while the two actively managed funds I've mentioned have excellent long-term track records, both have been trailing more recently as investors have taken a more "risk-on" view of the market. So, as with any investment approach, make sure funds like these are part of a wider, well-diversified portfolio with a long-term outlook.
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