Date
23 October 2017
Wrong reactions to extreme market volatility often result in big losses for investors. Photo: Nerdist
Wrong reactions to extreme market volatility often result in big losses for investors. Photo: Nerdist

A better way to handle market volatility

Famed financial blogger Ben Carlson recently shared the results of his study on the volatility and performance of three key stock indices – S&P500, Russell 2000 (a benchmark for US small caps) and MSCI Emerging Markets Index.

Since 1988, the average annual returns of these three indices have been quite similar, according to Carlson, but Russell 2000 and MSCI Emerging Markets Index have displayed much higher volatility than S&P 500 over the period.

From 1988 to the present, volatility of S&P 500 was 14.3 percent, 18.6 percent for Russell 2000 and 23.2 percent for MSCI Emerging Markets Index.

Carlson then devised a clever way to lower the risk while enhancing return by investing in the three indices in equal proportions, and then rebalancing it at the end of each year (by reducing his bet on the outperforming index and adding to the laggard.)

The better result – higher return and lower risk – comes from the fact that the three do not always move in tandem. For example, if one goes up, the other may go down.

Pooling them together, hence, reduces the overall volatility.

The rebalancing exercise also helps investors avoid the usual investment trap due to extreme market swings – chasing the market when stocks are expensive and dumping shares when they are weak.

Very few people have the capability to “be fearful when others are greedy and greedy when others are fearful”, as advised by Warren Buffett.

But by using Carlson’s approach, investors at least won’t commit the fatal mistake and do the opposite.

The full article appeared in the Hong Kong Economic Journal on Aug. 24.

Translation by Raymond Tsoi

[Chinese version 中文版]

– Contact us at [email protected]

CG

Columnist at the Hong Kong Economic Journal

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