Volatility can be an interesting thing in a portfolio.
For many short-term traders who make the "right" call, volatility can provide relatively easy, quick and substantial gains.
But of course, on the other end of that position, volatility can hurt an investor's portfolio with steep and painful losses.
While short-term traders have the risk tolerance and appreciation for such wild swings to the upside and downside, not all traders are enjoy this type of movement in their portfolio.
Safeguarding against volatility is not easily done without incurring costs that many investors would rather live without.
Strategies involving protective puts and covered call writing might sound well and good, but they require an investor's attention which is not always available.
For investors who take a buy and hold strategy, the only way to really safeguard against market volatility is to own actively managed mutual funds (i.
e.
non-index mutual funds).
This may seem like an overly simplistic statement and process, but the rationale makes perfect sense in hindsight.
To understand why funds are the best safeguard against severe market volatility, it helps to understand that volatility is not a sudden thing.
In other words, volatility does not "double" overnight, just as economic recessions do not bring the economy to a halt overnight.
Both processes take a bit of time and come with enough subtle warnings that when they do happen, they make some sense.
To illustrate this, consider that volatility will climb by 2% after a viciously volatile session.
It does not climb by 10% and it certainly does not double, which is the point at which many media sources will pick up the volatility and start reporting on it.
As well as slowly rising volatility (which cumulatively amounts to a large volatility swing), there are other technical indicators that will suggest some securities are more susceptible to negative market swings than others.
These will become areas of concern for a portfolio manager who can hedge such positions and take steps to minimize wild swings, whether that means selling part of the position or buying some kind of insurance to protect against the downside.
Because portfolio managers are looking at these types of quantitative figures on a daily basis, they are able to shift the weightings of their portfolios.
They realize that market volatility is inevitable and that volatility will push prices one way or the other.
But it is because of this realization that their investments with their dozens of securities and proper correlations will fluctuate that they can actually help investors weather the storms better than any other investment or investment strategy.
In summary, quantitative (or technical) analysis as well as subtle market clues (such as the volatility index) will alert mutual fund managers as to potential changes in particular securities or the market as a whole.
Managers can therefore take the defensive measures necessary to protect your capital.
No other investment product can do this with the professional efficiency of a mutual fund.
For this reason, mutual funds are a great core holding for any portfolio that needs protection against volatility.