An Overview of Low & High Volatility Investing Strategies: The Risks & Rewards

While the most popular amusement park attraction is the roller coaster, this thrill-seeking passion of slow climbs and rapid descents doesn’t translate to what most people seek when investing. In fact, last year, 64% of investors cited market volatility as one of their top portfolio concerns.

Let’s dive into this a bit further and take a look under the hood at volatility, how it is caused, and how investors can mitigate risk within their portfolios.

Understanding Volatility in Investing

Volatility - whether it’s used in chemistry, computer science, or finance - is simply a measurement of change. Things with higher volatility tend to fluctuate more frequently, dramatically, and unpredictably.

Within the world of investing, volatility can occur for a number of reasons. Liquid assets that are easier to trade are usually more susceptible to price swings as investors can enter and exit markets more quickly. Additionally, certain asset classes, such as the stock market, are usually more closely influenced by political developments or government regulations.

Tangible real assets with stable supply and demand, such as farmland, on the other hand, are typically less volatile than financial instruments with no intrinsic value - and this has historically held true during periods of economic downturn.

Investors have several ways to measure their investment’s volatility. Often used for stocks, a beta coefficient measures how likely the price of a specific asset will move compared to the entire market. The maximum drawdown of an investment is the peak-to-trough (highest price to lowest price) before a new high price is established. Standard deviation and variance are used to measure how far away, or how often, returns of an asset have historically deviated from the investment’s average return. Some of these indicators are used in technical analysis as well - for example, Bollinger Bands chart an investment’s standard deviation against the investment’s moving average price.

Constructing A Portfolio Around Volatility

High volatility in the stock market typically corresponds with declining markets, while periods of stable prices typically reflect stronger market conditions. Volatile markets often invoke investment decisions driven by emotion; 66% of investors admit to having made impulsive financial choices they later regret while 56% of investors are willing to pay a premium on stable assets that protect against volatility.

Still, some investors actively seek out volatility; price variations create opportunities for day-traders, and those looking at dollar-cost averaging may experience opportunities to invest at lower prices due to dips.

Many investors may associate volatility with risk and expect higher potential returns. However, volatility and risk are not one and the same. When an investment is volatile, its price can change dramatically either up or down. When an investment has a higher risk, there is often greater uncertainty in the investment’s future and a greater likelihood of permanent capital loss. Investments that are risky are defined by their potential downside and what an investor may lose; unlike riskier investments that often compensate for this downside with higher returns, volatile investments have historically delivered lower risk-adjusted returns than average investments.

A majority of investors seek to mitigate volatility in their portfolio, as it can compromise returns in the long-term.

Volatility Across Asset Classes

Here’s the historical volatility of several popular asset classes:

Equities

As we wrapped up 2021, the stock market finished the year with notable turbulence. These price swings have carried into 2022, with some intraday index prices swinging over 3%. Over the past decade, S&P 500 ETFs have experienced a standard deviation of around 13.45%, though a longer-term analysis of daily S&P 500 prices revealed a standard deviation over the past 100 years in excess of 20%. Small cap stocks can have even greater volatility than larger cap stocks.

Bonds/Fixed-Income

The logic behind traditional 60/40 portfolios is to mitigate equity volatility with bond stability. Over the past 25 years, the Vanguard Total Bond Market ETF had a standard deviation of 3.58%, while a blend of high yield bond ETFs had a standard deviation of around 6.94%. As the Federal Reserve begins to intervene with rising prices, bond prices have begun to experience more volatility than usual.

Precious Metals

Gold has a reputation for being a safer, more stable asset that protects against broader portfolio risk. Unfortunately, however, it can also be volatile; gold had a standard deviation of 19.19% over the past 50 years. After hitting an all-time high in 2020, gold’s peak-to-trough resulted in nearly a 20% drop the following year. Silver has experienced historically more volatility as a precious metal investment with a 10-year average standard deviation of 27.83%.

Cryptocurrency

A nascent industry, cryptocurrency provides an excellent benchmark of what higher volatility markets look like. With a current annualized standard deviation of 73%, Bitcoin has remained just as volatile as it was five years ago. Known for very bearish downturns, cryptocurrency has experienced prior-year peak-to-troughs of 90% drops in price.

Real Estate

The NCREIF National Property Index (NPI), which owns over 9,000 commercial real estate properties, reported a deviation of 7.25% between 1983 to 2020. More specific and less diversified real estate holdings are typically more at-risk for variation. The long-term standard deviation for NCREIF’s hotel index was 10.86% while the 10-year standard deviation of the Dow Jones U.S. Select Residential Index was 16.1%.

Farmland

Farmland has experienced historically less volatility than each asset class mentioned above, providing stability for investors even during prior market downturns. The standard deviation of the NCREIF Farmland Index from 1992 to 2020 was 6.9% while nationwide average farmland values have increased all but one of the past 12 years. Farmland’s Sharpe Index of 1.2 is three times bigger than large-cap stocks - indicating that the asset can outperform equity markets when factoring in the expected volatility of the investment.

Portfolio Risk Management

An often overlooked aspect of volatility mitigation is portfolio diversification; in fact, 42% of investors reported that they do not monitor their portfolios to ensure they are properly diversified. However, investing across multiple asset classes, industries, or holding periods is a market-wide approach to protecting against wide swings in prices.

Not only has farmland been a historically stable investment (especially compared to other alternatives), farmland returns have been historically uncorrelated with stocks, bonds, and real estate. Adding only farmland to a traditional portfolio of stocks and bonds historically increases average annual total returns while reducing the portfolio’s volatility. This has held true even during prior economic downturns; farmland has remained largely uncorrelated to broader market cycles.

Farmland: Low Volatility, Competitive Returns

Investment performance across various asset classes in recent years has been quite remarkable. For example, the S&P 500 experienced a peak-to-trough drawdown of -33.9% in 2020, yet still closed the year up by 18.3%. While some investors find this type of volatility appealing, others may seek returns without such fluctuations.

For those looking to reduce portfolio unpredictability, farmland presents a potential solution. It has historically delivered competitive returns, demonstrated low correlation with other asset classes, and maintained lower volatility as part of a diversified portfolio.