If you have a highly volatile stock portfolio, it can be an emotional roller coaster. Of course, some people like the thrill of a roller coaster, but the rest of us don’t want to feel anxious every time we check our stock portfolio. We just want to create wealth nice and slow and steady. Nothing special. All it takes is a few extra dollars a week in your pocket.
Fortunately, there are many quick and easy ways to reduce volatility in your stock portfolio. This article discusses three options: diversification, defensive stocks, and dollar-cost averaging.
1. Diversification
One of the easiest and quickest ways to reduce the volatility of your portfolio is to diversify your investments. Essentially, this means buying a variety of stocks and other investments and combining them into a portfolio.
Stock prices for different companies react differently to different events. For example, news of interest rate hikes will negatively impact the stock prices of growing companies with high debt levels, as borrowing costs increase. However, the prices of bank and insurance stocks, which tend to benefit from rising interest rates, may rise.
If you had a portfolio consisting only of growth stocks, you would suffer in this scenario. However, if you also owned banking or financial stocks, your stock gains may have offset other losses. Overall, simply increasing diversification should reduce portfolio volatility.
If you don’t have a lot of money to invest but want to quickly diversify your portfolio, exchange-traded funds (ETFs) are a good option. ETFs trade on the ASX in a similar way to ordinary shares, but are actually investment funds.
Some are designed to track specific indices, such as the iShares Core S&P/ASX200 ETF (ASX: IOZ). As the name suggests, some investors invest in commodities and other asset classes, such as the Global X Physical Gold ETF (ASX: GOLD), which invests in gold.
2. Defensive Stocks
Okay. They agree that diversification is good if you want to reduce volatility in your portfolio. But what if there was a specific type of stock you could buy to protect yourself if the rest of the market collapsed? In fact, there is such a thing as defensive stocks.
Defensive stocks belong to companies that perform well regardless of general economic conditions. These could be consumer staples stocks such as Coles Group Ltd (ASX: COL), healthcare companies such as CSL Ltd (ASX: CSL) or telecommunications companies such as Telstra Group Ltd (ASX: TLS). There is a gender. All of these companies provide goods and services that people rely on every day, so their profitability is less affected by economic downturns.
Think of defensive stocks almost like insurance. Defensive stocks tend to maintain their value even if the prices of other stocks decline. This means that adding some of these to your portfolio can help stabilize your portfolio even when market conditions are volatile.
3. Dollar-Cost Averaging
Another good way to reduce volatility in your portfolio is to pursue a dollar-cost averaging (“DCA”) investment strategy. Instead of investing a lump sum upfront, DCA proponents invest small amounts periodically over a long period of time, regardless of market conditions.
Granted, this may not be all that surprising, but the magic of this strategy is best illustrated with a simple example.
You want to invest his $1,000 in Company A, and you have the option of investing the money all at once now, or investing $200 a month for the next five months in five installments. Suppose you have a choice. Assume that the current stock price is $100, and that the stock will trade at $110, $90, $80, and $95 in the next four months.
If you invest all your money up front, your stock holdings over the next five months will be:
Lump Sum | Month 1 | Month 2 | Month 3 | Month 4 | Month 5 |
Shares Purchased | 10 | 0 | 0 | 0 | 0 |
Total Shares | 10 | 10 | 10 | 10 | 10 |
Market Price | $100 | $110 | $90 | $80 | $95 |
Value | $1,000 | $1,100 | $900 | $800 | $950 |
In this scenario, you bought 10 shares (each with a stock price of $100) for $1,000 in the first month. By the fifth month, the price of these stocks had fallen by 5% to $95. This means that his total investment also fell by 5% from $1,000 to $950. Pretty easy.
However, if you employ a DCA method, an interesting thing occurs.
DCA | Month 1 | Month 2 | Month 3 | Month 4 | Month 5 |
Shares Purchased | 2.0 | 1.8 | 2.2 | 2.5 | 2.1 |
Total Shares | 2.0 | 3.8 | 6.0 | 8.5 | 10.6 |
Market Price | $100 | $110 | $90 | $80 | $95 |
Value | $200 | $420 | $544 | $683 | $1,011 |
In this scenario, you would split $1,000 into five $200 investments each month, regardless of the stock price. In the first month, he can buy two stocks using $200 ($200 investment divided by $100 stock price). In the second month, the stock price has risen to $110, so you can only buy 1.8 shares ($200/$110). In month 3, the stock price has fallen to $90, so you can buy 2.2 shares ($200/$90).
Because you can buy more shares at a lower price, you will have 10.6 shares after 5 months instead of just 10. This means that the value of your portfolio is $1,011, an increase of 1% over your total investment of $1,000.
This means that even if the company’s stock price is lower today than it was five months ago, it will still be profitable using the DCA strategy. Pretty amazing, right?
Conclusion
This article discussed several strategies you can use to reduce volatility in your portfolio. Whether you want to diversify your portfolio to hedge against specific macroeconomic risks, invest more in defensive stocks to protect your portfolio from economic downturns, or use dollar-cost averaging to balance your returns over the long term. You can also take it.
However, which strategy is right for you depends on your risk tolerance and personal circumstances. Please consider your investment goals and objectives carefully before making any changes to your investment or portfolio strategy. If in doubt, consult your financial advisor.
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