Stocks and Bonds: What to Expect
June 18, 2021
Let’s talk investments.
Specifically, how the volatility of stocks and the returns of stocks are related.
Many investors dislike volatility. A stock can be worth $10 a share, increase to $15, decreased to $8, and then back up to $11.
Most would prefer a $10 a share price to increase gradually to $11. Perfect. A 10% return with no drama.
Volatility is a normal part of investing. As investors, we have to accept that if we own shares.
As it turns out volatility is our friend. Potential strong returns from owning shares are predicated on those shares having the risk of volatility.
You do have the option to eliminate stock volatility in your portfolio. Sell your shares and buy bonds and the level of volatility that you are likely to experience will be significantly less than if you had owned those shares.
But there is a problem.
The expected return on a bond is significantly less than the expected return of stocks. That is logical because a bond owner that has significantly less risk of volatility will accept a lower return as a trade-off for lower volatility.
On the other side, for an investor to own shares that can be volatile they will demand a higher rate of return. And the market will price stocks and bonds accordingly.
As investors, we accept the risk of volatility with the expectation that we will have a higher return.
This leads us to the important task of designing an investment portfolio that meets your needs.
Most people want a combination of stocks and bonds depending on their financial objectives, financial circumstances, personal tolerance to risk and timeframe for when these funds are needed.
This is referred to as asset allocation.
In my opinion, asset allocation is the most significant decision investors make. It will be the most significant determining factor of expected volatility and expected returns.
Peter Watson is registered with Aligned Capital Partners Inc. (ACPI) to provide investment advice. Investment products are provided by ACPI. ACPI is a member of the Investment Industry Regulatory Organization of Canada. The opinions expressed are those of the author and not necessarily those of ACPI. Peter Watson provides wealth management services through Watson Investments.