� Investing in Stocks With Consistently Rising Dividends . Legg Mason recently introduced its Low Volatility High Dividend ETF ( LVHD ) based on an investment strategy of sustainable high dividends and low volatility .
� Adding Bonds to the Portfolio . John Rafal , founder of Essex Financial Services , claims a 60 % -40% stock-bond mix will produce average annual gains equal to 75 % of a stock portfolio with half the volatility .
� Reducing Exposure to High Volatility Securities . Reducing or eliminating high-volatility securities in a portfolio will lower overall market risk . There are mutual funds such as Vanguard Global Minimum Volatility ( VMVFX ) or exchanged traded funds ( ETFs ) like PowerShares S & P 500 ex-Rate Low Volatility Portfolio ( XRLV ) managed especially to reduce volatility .
� Hedging . Market risk or volatility can be reduced by taking a counter or offsetting position in a related security . For example , an investor with a portfolio of low and moderate volatility stocks might buy an inverse ETF to protect against a market decline . An inverse ETF – sometimes called a “ short ETF ” or “ bear ETF ” – is designed to perform the opposite of the index it tracks . In other words , if the S & P 500 index increases 5 %, the inverse S & P 500 ETF will simultaneously lose 5 % of its value . When combining the portfolio with the inverse ETF , any losses on the portfolio would be offset by gains in the ETF . While theoretically possible , investors should be aware that an exact offset of volatility risk in practice can be difficult to establish .
2 . Timing
Market pundits claim that the key to stock market riches is obvious : buy low and sell high . Good advice , perhaps , but tough to implement since prices are constantly changing . Anyone who has been investing for a time has experienced the frustration of buying at the highest price of the day , week , or year – or , conversely , selling a stock at its lowest value .
Trying to predict future prices (“ timing the market ”) is difficult , if not impossible , especially in the short-term . In other words , it is unlikely that any investor can outperform the market over any significant period . Katherine Roy , chief retirement strategist at J . P . Morgan Asset Management , points out , “ You have to guess right twice . You have to guess in advance when the peak will be – or was . And then you have to know when the market is about to turn back up , before the market does that .”
This difficulty led to the development of the efficient market hypothesis ( EMH ) and its related random walk theory of stock prices . Developed by Dr . Eugene Fama of the University of Chicago , the hypothesis presumes that financial markets are information efficient so that stock prices reflect all that is known or expected to become known for a particular security . When new data appears , the market price instantly adjusts to the new conditions . As a consequence , there are no “ undervalued ” or “ overvalued ” stocks .
Coping with Timing Risk Investors can mollify timing risks in single securities with the following strategies :
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Dollar-Cost Averaging . Timing risks can be reduced by buying or selling a fixed dollar amount or percentage of a security or portfolio holding on a regular schedule , regardless of stock price . Sometimes called a “ constant dollar plan ,” dollar-cost averaging results in more shares being purchased when the stock price is low , and fewer when the price is high . As a consequence of the technique , an investor reduces the risk of buying at the top or selling at the bottom . This technique is often used to fund IRA investments when contributions are deducted each payroll period . NASDAQ notes that practicing dollar-cost averaging can protect an investor against market fluctuations and downside risk .
Index Fund Investing . In the classic example of “ If you can ’ t beat them , join them ,” Fama and his disciple , John Bogle , avoid the specific timing risks of owning individual stocks , preferring to own index funds that reflect the market as a whole . According to The Motley Fool , trying to accurately call the market is beyond the capability of most investors , including the more prominent investment managers . The Motley Fool points out that less than 20 % of actively managed diversified large-cap mutual funds have outperformed the S & P over the last 10 years .