� 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.