How You Could Have Avoided Much of the Volatility

Posted by Alex Frey (@alexhfrey )

When faced with extraordinary volatility like we have seen in recent days, it can often seem like there is no place for an investor to hide. But that's actually not quite true.

While US stocks are down almost 5% month to date (or at least this was true when I was writing it -- who knows by the time you read it...), with even sharper falls in Europe, the IvyVest portfolio has held up relatively well, losing only 1.1% in value during that time.

The difference is not due to our amazing stock picking or market timing abilities (we use low-cost ETFs that provide broad market exposure and adjust allocations slowly in response to a long-term model). It's simply a result of diversification.

This rough period in stocks has coincided with nice returns to Treasuries (+4.8%), REITs (+4%), Gold (+2%), and TIPS (+ 1.8%).

Performance Since Sep 30 (as of sometime mid-day October 15)

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These four assets are not coincidentally the "defensive" assets in our model -- ones that were put there to hold up when the markets turn south. As of September 30, we had 39% of the portfolio in these kinds of assets, versus 61% in growth assets (or "offensive" assets) like stocks and commodities (REITs are considered 50% in each camp).

This 30% allocation was up from less than a 20% allocation to defensive assets last year, mostly because in the intervening months the valuation of the overall stock market has increased rather dramatically, making stocks a somewhat less attractive bet vs. bonds.

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The increase in weights to defensive assets helped to smooth overall performance in the last month.

If your approach to "diversification" only consisted of buying different kinds of US stocks, then you would have a very different view, as there hasn't been much refuge to be found in any of the popular areas, like high dividend stocks.

If you want to lower volatility, you need to own defensive assets as well as growth assets.


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By Alex Frey