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Colin OShea

July 11 , 2016

Why Reducing Volatility Matters for Increasing Long-Term Returns

Why Reducing Volatility Matters for Increasing Long Term Returns

Last week’s article discussed the process by which Security National Bank reduces non-systemic risk or volatility through diversification. This week we will cover why reducing volatility through diversification can increase returns over the long term.

Since assets do not move up and down in perfect correlation, having exposure to a diversified mix of stocks and/or bonds not only reduces volatility, it can increase long-term returns. Diversification protects a portfolio from the bumpy ride experienced in the stock market especially over longer periods. In fact, a portfolio balanced between stocks and bonds has not experienced a rolling five-year period of negative returns in the last 65 years. A diversified portfolio of 60 % stocks and 40% bonds declined significantly less than a portfolio invested only in stocks during the great recession. Losing less as the stock market declined enabled the diversified portfolio to recover its losses faster than the all-stock portfolio (see chart 1).


Chart 1.


Reference: J.P. Morgan Asset Management


Maintaining a diversified portfolio that is appropriate for your risk tolerance is an important part of the investment process but not the end. After creating a diversified portfolio based on a client’s risk tolerance, Security National Bank periodically rebalances the portfolio. Rebalancing a portfolio entails systematically capturing the gains of assets that have appreciated over time and reallocating the proceeds to assets that are under their desired weight. This not only keeps the allocation between stocks and bonds near the target percentages, it further reduces the volatility of a diversified portfolio. 


Diversifying and rebalancing a portfolio can provide returns in line with the overall market with less volatility. The diversified or asset allocation portfolio shown in chart 2 has a mix of 65% stocks/alternative/satellite investments and 35% bonds and was rebalanced annually. The regularly rebalanced asset allocation portfolio returned an average of 5.6 % more per year over the last 15 years ahead of the U.S. and world stock markets with less volatility.


Chart 2.


Reference: J.P. Morgan Asset Management


Maintaining a perspective on market volatility, investing over the long term and having a properly diversified portfolio can increase returns while reducing volatility. Contact your Wealth Management Advisor today to see how we diversify and rebalance your portfolio to meet your goals while reducing risk.


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