How to Find and Invest in Low Volatility Stocks

Look for stocks with steady returns and few wild price swings

Stock Market

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Investors looking for solid, steady returns over a long period of time should generally avoid stocks that have wild changes in value. When a stock goes up and down in extreme fashion, it can be harmful to overall long-term returns and can also be emotionally exhausting for the investor.

Stocks with high volatility are especially risky for those investors close to retirement age, because of the possibility of losing money quickly. While it’s possible to make money on volatile stocks and some volatility is OK if overall returns justify it, most investors are best off searching for stocks with relatively low volatility and a track record of steady positive returns.

Stocks with low volatility aren’t always easy to spot but can be found as long as you have a good understanding of what volatility is and how it can be measured.

The Basics of Volatility

To help explain volatility and why it matters, let’s examine two imaginary stocks and their five-year annual returns.

Company A:

Year 1: +12 percent

Year 2: -5 percent

Year 3: +18 percent

Year 4: -11 percent

Year: 5: +21 percent

This company has an average, or mean, annual return of 7 percent. But, as you can see, returns are not consistent from year to year.

Company B:

Year 1: 7 percent

Year 2: 9 percent

Year 3: 5 percent

Year 4: 6 percent

Year 5: 8 percent

The annual returns of this second company look very different than Company A, but the annual average return is the same. Both of these stocks have an average annual return of 7 percent, but the first company is far more volatile.

Why does this matter? Because big changes in annual returns can have an abnormal impact on the compounding value of an investment.

Let’s examine these imaginary companies again, assuming that you are investing $1,000 to start. We’ll examine the total amount of money you’ll have at the end of each year, based on the returns above.

Company A:

Year 1: $1,120

Year 2: $1,064

Year 3: $1,255

Year 4: $1,086

Year 5: $1,314

Company B:

Year 1: $1,070

Year 2: $1,166

Year 3: $1,224

Year 4: $1,297

Year 5: $1,400

As you can see, investors in Company B have more money at the end of the five-year period than those who invested in Company A. That’s because when a company loses money in one year, it has to earn much more the next year to make up for the loss.

Investors in Company B not only ended up with more money, in the end, but they also didn’t have to deal with the emotional swings of watching the stock go up and down wildly. Moreover, an investor close to retirement age would, ideally, not want to see any investment go down precipitously, as they may choose to retire before the stock price has a chance to rebound.

Determining Volatility

It’s not always easy to determine how volatile a stock is. You can examine a stock price and see how it moves up and down, but that’s only modestly useful when viewing it out of context. When examining volatility, it’s important to consider the volatility of other stocks in the same industry and sector, as well as the movement over the overall stock market.

Fortunately, there are actual measurements of volatility that can give you an objective picture. I like to look at a measure called “Beta,” which you can usually find when researching a stock online. In most cases, a Beta figure simply compares a company’s volatility to the S&P 500 Index, which tracks the largest companies in the stock market. A measure of “1” means the stock price moves almost perfectly in line with the S&P 500. A measure of “1.25” suggests it is 25 percent more volatile than the index.

When listing stocks, most online brokerage firms will show the Beta for a company, but also the Beta for that industry. For example, as of April 2018, Apple showed a Beta of 1.03, making it slightly more volatile than the S&P 500. But the average Beta for the information technology industry is 1.27. Thus we can say that Apple is more volatile than the stock market in general but less volatile than most tech stocks.

Low Volatility Sectors

Some sectors and industries are, by nature, less volatile than others. Tech stocks, for example, tend to be more volatile than utilities. It’s also worth noting that larger companies tend to have less volatile stock prices than smaller ones.

Many financial advisors point to the consumer staples sector as one with low volatility and strong returns. This sector includes companies that produce essential products that we use every day, such as household items, food, and beverages. As a result, these companies don’t see wild swings in earnings, so their stock prices don’t swing wildly, either.

Popular Low-Volatility Stocks

Over the years, there have been a handful of stocks that have garnered consistent positive returns without wild changes in value. Many of them are well-known companies that have been around a long time and have dominated their respective industries.

They include:

Procter and Gamble [NYSE: PG]: One of the titans in the consumer staples sector with a Beta far below average.

Coca-Cola [NYSE: KO]: Another low-beta company that’s been around forever and rarely disappoints. There’s a reason Warren Buffet owns hundreds of millions of shares of Coke.

Lockheed Martin [NYSE: LMCO]: The world’s largest defense contractor has long been a stable performer and its stock price is not prone to extreme swings.

Rockwell Collins [NYSE: COL]: Another defense and industrial firm with steady earnings and, and with one of the lowest beta numbers among big companies.

Easy Ways to Invest in Low Volatility Stocks

If you’re not keen on doing a lot of legwork to find low-volatility investments, you can get good exposure to them through mutual funds and exchange-traded funds (ETFs) that invest exclusively in these types of stocks.

One of the most popular low-volatility investments in the last couple years is the iShares MSCI Minimum Volatility ETF [NYSE: USMV], which looks to invest in stocks that are less volatile than the market as a whole. Other similar ETFs include the Invesco S&P 500 Low Volatility ETF [NYSE: SPLV] and the Vanguard Global Minumum Volatility Fund [NYSE: VMVSX].

It’s up for debate as to whether these ETFs consistently perform any better than the market as a whole, but they could be a useful part of a broad investment portfolio, especially during times when the stock market is fluctuating wildly.