Volatility: the very word can send shivers down the spines of even seasoned investors. When we think of stock market crashes, lost fortunes and anxious insomnia, these images immediately come to mind. What if I said that volatility is something to embrace, not escape. In fact, it can lead the way to huge bottom-line gains! This change in mindset requires both education and strategy. It requires a good bit of audacity too, but the upside can be huge.
Armed with in-depth market analysis, tools, and insights, our investors will be in an entirely different class than their competition. That means learning how to thrive, not just survive, in increasingly volatile environments. It’s metaphorically speaking, turning the scared into opportunity.
To some investors, volatility is the very definition of risk. And that’s hardly surprising—unchecked, it is a recipe for billions in unnecessary losses. The instinctive reaction in times of volatility is to retreat, to run for the supposed shelter of cash or ultra-low risk investments. That focus can lead to passing on some of the most profitable opportunities.
Think of it this way: volatility is like a sale sign at your favorite store. When things go on sale, so to speak, that’s time for you to pounce and get into assets at a better price. The trick is to identify value-focused opportunities with good underlying fundamentals. These investments can now be short circuited by transient market chaos, thus producing incredible chances.
Needless to say, tracking down these opportunities takes a keen eye and a deep grasp of market forces. This is why understanding historical volatility measures, analyzing implied volatility, and tracking the VIX index itself all become crucial tools in your volatility strategy toolbox. Understanding whether volatility is "clean" (driven by broad market events) or "dirty" (caused by specific, isolated incidents) is crucial.
One of the very first and simplest strategies for overcoming volatility is diversification. Diversifying investments through multiple asset classes, sectors and geographic regions mitigates the risk of losing everything due to one fatal flaw. It’s the same as constructing a robust vessel that’s able to survive through even the roughest sea.
Now, I remember once going all in on one individual tech stock. When that company went through an unexpected disaster, that set my portfolio back by a good margin. Here’s how I learned that painful lesson. It helped open my eyes to the HUGE importance of diversification and how that can HURT you putting all your eggs in one basket.
Outside of diversification, there are other, much more active strategies for mitigating risk and capitalizing on volatility. Hedging, employing instruments such as options or futures, can safeguard against potential losses. With dollar-cost averaging, investing a set amount at consistent intervals helps minimize the effect of price volatility. Stop-loss orders or stop-loss limits automatically sell an investment if its price drops below a set price point, which can help protect potential downside.
While volatility does lead to challenges, it creates distinct opportunities for income generation as well. In short, fixed today is less about the income and more about the rates. Markets filled with uncertainty can be an excellent time to capture yield all while maintaining significant liquidity. Private debt strategies, like lending to high-quality companies with strong fundamentals, for instance, can earn total return as the credit cycle plays out.
Finally, volatility can provide opportunities to diversify a region’s exposures in relation to shifting geopolitics and growth patterns. If you’re new to this, now is the time to get ahead of the game and start building your portfolio. Rebalance to capture new opportunities and invest in under-indexed areas!
Based on my practical experience, hedging FX risk during times of elevated volatility can add an extra 2% per year. These are just some of the strategies that can help turn a difficult market landscape into a foundation of stable, persistent returns.
While the promise is great, it’s important to recognize the risks. Analysis indicates that in months of above-normal volatility, US equities tend to generate a negative risk-adjusted return at an annualized horizon. This move away from transit is true on average. Equity volatility has a negative effect on returns of US equity and US government bonds. On the flip side, during the high-volatility months, the S&P 500 declines almost 0.3% per month on average.
This is where strategic overlays and active management for safety come into play. For example, REITs (Real Estate Investment Trusts) greatly increase returns in those months when volatility moves from high to low. Their returns outperform an average monthly holding return of 2.24%. Similarly, non-US developed countries’ bonds have outperformed AGG (a broad bond market ETF) or TIPS (Treasury Inflation-Protected Securities) in high-volatility months.
What’s more, adding strategies such as the Crossgates DFP Overlay makes it possible to outperform during down months with considerably less volatility. Using this overlay, the S&P 500 has provided substantially greater returns than it has by itself. On average, it has a monthly return of 0.84%.
The most important lesson, I think, is that volatility isn’t good or bad in itself. It’s a temporary solution, but like any tool, its effectiveness depends on the skill and knowledge of the user. As a result, investors who use volatility to their advantage will be better equipped to find financial success. They achieve this by mastering its fortunes, using smart risk management practices, and pursuing opportunity with intent.
The market is going to continually throw curveballs. The ultimate question, though, is whether you’re ready to take a big cut. Embrace a learning attitude and arm yourself with a fresh perspective. You can not only survive volatility, you can learn to turn it to your advantage. It’s all about welcoming the disruption, figuring out how to surf those waves, and at the end of the day, cashing in on the ride.
