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Protecting Your Portfolio Against Volatility

Volatility should always top of mind for investors. Remember the crash of 2008, when the VIX—a popular measure of market volatility—more than quadrupled in a span of two months? In recent weeks, the so-called VIX fear index has again been on the rise. Between July 3 and July 10, it rose from 10.32 to 12.59, though it has since declined somewhat.

Prudent investors should consider sitting down with their advisor and discussing potential areas at risk of volatility in their investment portfolios. Some investors wonder why volatility in and of itself a bad thing. After all, volatility, by its simplest definition, is just the dispersal of the return of a security (for example, a stock or a bond) around its average return. As long as the security dispersal shows more ups than downs, an investor wins, right?

Not necessarily. Historical analysis suggests that securities that deviate more from their average returns carry more risk. Moreover, other studies indicate that higher market volatility correlates with greater odds for a declining market.

One way of gauging the potential susceptible to market volatility of a particular security is to look at its beta. For example, an individual stock with a beta of 1.0 is expected to move roughly in line with the S&P 500. Beta below 1.0 indicates relatively lower volatility, and vice versa. TheStreet.com offers a more detailed explanation here.

Ultimately, a well-diversified, professionally managed portfolio may be your best protection against volatility. By working with a financial advisor to regularly review your portfolio for volatility risks, you may be able to better protect yourself against market swings.