Market volatility can erode a portfolio’s value

Volatility is a measure of market risk based on fluctuation of returns in response to external factors, both negative and positive. Economic surprises, geopolitical events and even investor sentiment can cause sharp market movements up or down. Volatility is typically represented by standard deviation, which measures the variance in the average returns of a specific market or investment over time. Less variance means lower volatility and therefore lower risk.


Volatility is on the rise

The past several years have seen increased volatility in the financial markets. For instance, average volatility (standard deviation) of the S&P 500 Index during the 1990s was 12.49% but since 2000 average volatility increased to 13.69%.1

The chart below illustrates this trend, with a relatively smooth upward curve through the 1990s but significant swings up and down since about the year 2000.

Volatility has been on the rise

Growth of $100,000 in the S&P 500 (1990 - 2015)

Chart: Volatility has been on the rise

Investors have paid the price

One byproduct of volatile markets can be significant downturns, which require even larger recoveries. For instance, after a 40% decrease in an investment’s value, you need an increase of nearly 70% in order to return to where you started.

It can take years to recover from a market downturn

A $500,000 portfolio's recovery from a 40% decline

Chart: It can take years to recover from a market downturn

Like a roller-coaster ride, market volatility can also induce anxiety in many investors. Frequently, market sentiment is lowest when opportunity is strongest. Rather than buying when markets are at their lowest and set to rebound, many investors buy at market highs and sell at market lows, which often results in underperformance.

Investing and emotions

The average investor underperformed (20-Year annualized returns)

Chart: Investors have underperformed

Alternatives can help lessen
portfolio volatility

By integrating differentiated sources of return, such as alternatives, investors can decrease their reliance on traditional market performance and potentially lessen their overall portfolio risk. It should be noted that diversification strategies do not ensure profits or protect against losses in declining markets. However, in general, alternatives rely less on broad market trends and more on the strength of each specific investment.

Alternatives offered an attractive risk/return tradeoff

Returns and volatility of selected asset classes (2006-2015)

Chart: Alternatives have offered attractive returns with less volatility