Resource Logo

Hello, you are using an old browser that's unsafe and no longer supported. Please consider updating your browser to a newer version, or downloading a modern browser.

Receive Updates
Resource Arrow Back to all
Date: February 26, 2018
Category: Alternative Investments

How Volatility Can Drag Down Investment Returns

When thinking about their portfolios, many investors focus on long-term outcomes such as total returns or income. If they think about volatility at all, they usually equate it with risk and write it off as unavoidable—the emotional price paid for investing.
However, volatility should not be ignored. It’s a profound force that can have a dramatic effect on the performance of a portfolio over time.1

What is volatility?

In its simplest form, market volatility is a measure of how much stock prices rise and fall from day-to-day.2 We usually define stock volatility in terms of standard deviation, which measures how much a price varies around its average.

The chart below shows the weekly returns of two hypothetical stocks, both of which start trading in week 1 at $10 and end week 10 at $11 (see table). Both offered a simple return of 10 percent, but the standard deviation of the returns for Stock A was 4.9 percent, while the standard deviation of returns for Stock B was 50 percent. In any given week, Stock B’s return could have been 50 percent higher or lower than its average weekly return, while stock A hardly moved from its average.

From your perspective, this illustration may suggest that volatility doesn’t matter because both stocks ended up in the same place ($11) and offered the same simple return (10 percent). But that’s not quite correct.

Volatility and investing

Volatility has the potential to erode portfolio returns through volatility drag. Let’s look at some examples.

The difference between simple average returns (which are commonly reported by mutual fund managers) and true returns is known as volatility drag.

The chart and table below illustrate the impact volatility drag can have on a portfolio.3 There are three scenarios here, all of which experience regular ups and downs—for example, in Scenario A, the portfolio rises 10 percent in year 1, then falls 5 percent in year 2, rising 10 percent again in year 3 and so on.

In all three scenarios, the simple average return over 20 years is 2.5 percent. However, the magnitude of volatility is different, and this has a major impact on compound annual growth rate (CAGR), which is the true measure of portfolio performance.4

In the low-volatility scenario, investors would experience a (CAGR) of 2.23 percent and see their money increase 70 percent over 20 years, while in the high-volatility scenario, investors would have lost 67.8 percent of their money and experienced a CAGR of -4.61 percent.

First, it’s better to have modest growth with modest volatility than it is to have huge growth with major volatility. Second, managing volatility at the portfolio level can be a major driver of long-term performance.

Including an allocation to real estate alternatives that have a low correlation to traditional asset classes may help diversify your portfolio and lower overall volatility. In the long-term, this may help you avoid both anxiety and investment underperformance.

1 Swan Global Investments. Volatility is a Drag. 9/27/16.

2 Yale Insights. Why Does Market Volatility Matter? 11/23/11.

3 Massachusetts Financial Services. Volatility: Returns Down the Drain. 2/15.

4 Seeking Alpha. Volatility Drag. 5/27/10.
This information is educational in nature and does not constitute a financial promotion, investment advice, or an inducement or incitement to participate in any product, offering or investment. It is not intended to be used as a tool to determine your specific financial situation, tax status, investment objectives, investment experience, suitability for any specific investment, risk tolerance or investment profile. Resource is not adopting, making a recommendation for or endorsing any investment strategy or particular security. The materials included herein are the property of Resource and may not be repurposed in a separate likeness without the express written consent of Resource.

Receive Updates

* These fields are required.

Emails and white papers can only be sent to financial advisors in Resource’s broker-dealer partnership network.

Resource is the marketing name for Resource Real Estate, LLC, Resource Alternative Advisor, LLC, and their affiliates. Resource may distribute certain products through Resource Securities LLC, a wholly owned broker/dealer, Member FINRA/SIPC

All statements and information other than statements of historical fact included on this website regarding strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans and objectives of management are forward-looking statements. When used on this website, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. You should not place undue influence on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make on this website are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved because of the number of risks and uncertainties, many of which are beyond our control, including but not limited to uncertainties concerning the properties being operated and sold or refinanced, leverage and meeting debt service obligations, operating properties in different locations throughout the U.S., general, market or business conditions and changes in laws or regulations. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. To check the background of Resource Securities LLC or any registered individual, please go to FINRA’s BrokerCheck.