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 Corporation (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.