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Lower Volatility Enhances Returns
 

 
As a prudent investor, you want to design your portfolio to have as little volatility as possible. Why? Because too much volatility can serve as a roadblock to achieving your goals.
 
Let’s look at two portfolios, A and B, in the following table. Each portfolio began as a $100,000 investment and experienced an average annual return of eight percent over five years. At first glance, the two portfolios look identical in terms of past performance. But take a closer look and you’ll notice that portfolio A had a greater value at the end of the five-year period. How can that be, given that the two portfolios had the same average annual return?
 

Portfolio A: Consistent Investment

Portfolio B: Volatile Investment

Year

Rate of Return

Ending Value

Rate of Return

Ending Value

1

8%

$108,000

30%

$130,000

2

8%

$116,640

–20% 

$104,000

3

8%

$125,971

25%

$130,000

4

8%

$136,049

–20% 

$104,000

5

8%

$146,933

25%

$130,000

Arithmetic return

8%

 

8%

 

Compound return

8%

 

5.39%

 

 
The answer can be found in the “rate of return” column for each portfolio. Portfolio A’s annual return remained at a steady eight percent each year, while portfolio B showed significant up-and-down swings from year to year. Portfolio B’s higher volatility led to a lower “compound” return – a number that, unlike average annual return, reflects volatility’s impact on an investment – and, as a result, a lower ending value.
 
This example illustrates an important truth: that investment volatility is detrimental to investment growth. When it comes to investing, a smoother ride is the way to go. You’ll face fewer emotional curves on your trip, and you’ll be more likely to reach your destination with greater wealth.
 
At Grand Wealth Management, our investment approach seeks that "smoother ride" through diversification. Client portfolios are invested in a broad range of asset classes to enhance returns and manage the risk of investment volatility.
 
 
This article is adapted from our white paper, The Informed Investor: Making Smart Investing Decisions in Today’s Volatile Market.


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