Question on matching volatility

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Jeffreyalan
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Question on matching volatility

Post by Jeffreyalan » Sun Apr 22, 2018 7:16 pm

Trying to soak up everyone’s knowledge here. Whenever someone asks can I use ZROZ instead of TLT or QQQ instead of Total Stock Market, the answer is usually no because it is too volatile compared to the other PP components.

My question is, assuming you don’t mind a bit more volatility, why is this a bad thing? Why do the component’s volatility need to match? It seems to me that more volatility means more chances to take advantage of rebalancing. ZROZ beats TLT on backtesting so your personal queasiness to volatility aside, isn’t it better to end with more $$?
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Mark Leavy
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Re: Question on matching volatility

Post by Mark Leavy » Sun Apr 22, 2018 11:58 pm

Two things to consider.

1) Think of volatility as 'maximum draw down'. This isn't the technical definition, but it is the definition that matters to your portfolio. Anything with the potential for a large draw down needs to have a portfolio percentage allocation that will allow you to sleep at night. If you have bought into a 25% allocation for 30 year T-Bonds, then switching to Zeros is NOT the same risk profile and you should re-evaluate what percentage of your portfolio to assign to these types of bonds. This, of course, applies to any volatile asset. You CAN use zeros - but you should know what you are doing and you should select a percentage of your portfolio based on something you can sleep with. Personally, I think backtesting is a necessary but insufficient criteria.

2) Generally speaking, a diverse portfolio carries assets that are not correlated. Not correlated and not inverse correlated. Close to zero correlation. In that case, you would like to hold an asset in a percentage portion inverse to its volatility. i.e more volatile, lessor percentage. This minimizes draw down risk for a given CAGR. Basic portfolio theory.
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Hal
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Re: Question on matching volatility

Post by Hal » Mon Apr 23, 2018 2:42 am

You may wish to read this article

http://www.stableinvesting.com/2014/11/ ... on-as.html

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Re: Question on matching volatility

Post by boglerdude » Mon Apr 23, 2018 10:47 pm

Youre right OP. Im tempted to just hold EDV, emerging markets, and high yield cash
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Hal
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Re: Question on matching volatility

Post by Hal » Tue Apr 24, 2018 2:43 am

Hmmm.... Very similar standard deviations (Yahoo Finance)

EDV 22.62
GLD 24.61
EEM 24.73
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