Ultimate Guide to Reducing Volatility with Asset Allocation
Market volatility can be unnerving, even for the most seasoned investors. While fluctuations are to be expected, no one likes watching the value of their portfolio fall substantially over a short period of time. If you’re one of the many investors looking for ways to reduce the impact of market volatility on your portfolio, continue reading to learn more about how asset allocation can help you do just that.
What is Asset Allocation?
Simply put, asset allocation refers to how much of each investment class you hold in your portfolio. While there are some general rules of thumb to follow, there is no one-size-fits-all formula for asset allocation. Instead, your investment decisions and asset allocation should be based on your financial goals, risk tolerance, and time horizon.
Types of Asset Allocation
There are several different categories of assets (also known as “asset classes”) to choose from. These include:
- Real Estate
- Precious metals
What is Asset Diversification?
Asset diversification means owning a variety of investment types within a particular asset class. While asset diversification and asset allocation are closely related concepts, they are not the same thing, and it’s important to distinguish between the two.
Asset allocation refers to the percentage of each asset class you hold, while asset diversification refers to the variety of investments you hold within a particular class. For example, if an asset allocation of 55% stocks, 35% bonds, and 15% real estate suits your needs, but your entire 55% stock allocation is invested in large-cap energy stocks, your portfolio lacks asset diversification.
Having the right mix of allocation and diversification based on your age and risk tolerance can help you manage market volatility and reach your long-term financial goals.
What is Market Volatility?
Volatility refers to the rate at which the value of a security, index, or market changes over a specified period of time. Market volatility is often associated with significant risk. While risky investments can surge and make you money, they can also crash and lose you money, so it’s important to build your portfolio in a manner that aligns with your goals and risk tolerance.
A variety of factors can influence market volatility, including economic factors, fiscal policy, interest rates, inflation trends, and political developments.
How to Assess Market Volatility
The Cboe Volatility Index (VIX) is one of the best indicators we have when it comes to detecting market volatility and measuring investor risk. Because it is derived from the prices of S&P 500 (SPX) options with near-term expiration dates, the VIX generates a 30-day volatility projection.
Strategies to Reduce Volatility with Asset Allocation & Diversification
There are a few different asset allocation and diversification strategies you can use to reduce your portfolio’s exposure to volatility.
Diversify Your Investments
Effective risk management often means diversifying across asset classes (stocks, bonds, real estate, commodities, etc.) and within those classes (e.g. a mix of small- and large-cap companies across a variety of sectors).
Consider Dividend-Paying Stocks
There are a number of potential benefits to investing in dividend-paying stocks, especially for income-minded investors who want to increase or maintain their stock allocation without incurring too much risk. It’s always a good idea to look at how long a company has been paying dividends and whether or not they have increased over time.
Choose Investments With Low Correlation
One aspect of diversification that is often overlooked is correlation. Even if you own a variety of investments across different asset classes, if they all trend upward or downward together, your portfolio isn’t as diverse as it could be and is still vulnerable to market volatility. Look for investments with low correlation to further diversify.
Use Dollar-Cost Averaging
Dollar-cost averaging (DCA) involves dividing the total lump sum you wish to invest in a stock or bond into multiple smaller investments of equal amounts, which you spread out evenly over regular intervals. The idea is that DCA can help reduce the impact of market volatility and prevent you from making one large, poorly-timed investment that could result in a significant loss.
Find the Optimal Asset Allocation for You and Your Goals
Are you looking for ways to diversify your portfolio and reduce the risks associated with market volatility? The financial experts at Chatterton & Associates can help you identify strategies to do just that, taking your unique situation, risk tolerance, time horizon, and personal preferences into consideration. Don’t hesitate to contact us today to set up a private, one-on-one consultation.
The Team at Chatterton & Associates
There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss.