What are the best strategies for managing volatility?
“By building a diversified portfolio, the whole is less volatile than the individual parts.”
All investments experience volatility. Even
Illiquid investments like real estate or hedge funds appear similarly stable; however, just because an asset
Changes in value can be slow or fast, but one thing to keep in mind is that volatility is difficult to predict, especially in the short term. So how do you manage such changes when they
The first approach involves supervising investments. The best managers do not ignore information, but they recognize which information is essential and which information is a distraction. They learn the history and characteristics of the people or instruments they are managing and use knowledge and experience to avoid making unnecessary or harmful changes.
As a student studying electrical engineering, I learned the concept of the signal-to-noise ratio. Noise is everywhere, and it can overwhelm signals that
One caution is always to ask if the historical conditions and assumptions remain valid when tuning to a signal. This oversight was a critical mistake made by many in the 2007–08 financial crisis. If the signal is now on a different frequency, you may need to change the channel to understand what’s
Study and experience also help to conquer the fear that
Valuable tools in managing volatility involve written expectations for upside and downside possibilities and maintaining diversification in your portfolio. If all your money is in a single investment, industry or asset class, it all becomes subject to the same factors causing
Finally, understanding the correlations among investments can further reduce the effects of volatility while preserving expected returns. For example, investing in a company that is a consumer of energy along with a company that is a producer can often help the risk-return metrics of a portfolio.
A mixture of stocks and bonds (regardless of the short-term outlook for each) has historically been a good strategy to maximize return with
The second approach to management is