“The craziest markets I can remember”
For the past week, the volatility in the markets has been at nosebleed levels, higher than anyone’s comfortable with. Our co-founder Dr. Richard Smith probably said it best:
And that’s coming from somebody who started investing around the time of the dot-com bubble.
The value of a resilient portfolio — one where you know and can account for the riskier bets you might be taking—is more apparent than ever. You want to make sure that, even in crazy markets, you’re set up for the best long-term success.
If you’re a long-term investor, this is the kind of test you have to weather every once in a while, unfortunately. Every time, it feels like everything’s crumbling. Even those consistent, old-reliable assets in your portfolio start to twist in the wind.
This might be the hardest advice to take, but we’ll offer it anyway: don’t panic. It’s not going to help. It’s time to plan.
Volatility isn’t temporary
Nobody knows when the market will calm down again. But we do know that, even after equities settle back into a groove, there are whole classes of assets that stay volatile year-round.
Take crypto, for example. Bitcoin ($BTC-USD), whatever feelings you might have about it, is a perfect example. If you’ve got a portfolio of mostly traditional assets, and you look at Bitcoin’s performance over the last 3 years, you can’t help but feel like you’re missing the boat.
But it’s been wildly volatile the whole time. Its daily ups and downs make the S&P 500 of the last few days look like smooth sailing. The upswings are crazy high and crazy fast, and the downturns are absolutely vertigo-inducing.
That’s par for the course. It’ll probably be many years before we find cryptos behaving anything like an average stock or bond.
These few weeks of volatility we’re weathering right now are pretty good training for a more volatile future.
But if you want to start getting your feet wet, and build cryptos into your portfolio, you tend to hit a roadblock. The indicators and metrics that we use for well-established assets — like Apple ($AAPL), for example — don’t help us evaluate cryptos.
We need new metrics that illustrate what kind of risk you’re taking on as you build a portfolio.
Take a look at $AAPL over the last year:
Compared to, say, Terra ($LUNA-USD), a relatively new crypto:
From those traditional price-over-time graphics, you’d barely know that owning each of these is a vastly different experience.
For that, you need metrics that prioritize risk.
Metrics designed for risk analysis
In RiskSmith, there are a few metrics we highlight: Risk Efficiency, dScore, and the histogram, which is a visualization of an asset’s daily returns.
Taken together, these three metrics give you a pretty good idea of what it’s been like to own over the last year.
Let’s look again at $AAPL. Its RE is 0.92, which is solid, but not exceptional. It’s doing a competent job of converting risk to reward.
Its dScore is 2.58%, which is on the high end, but for a tech stock, it’s not crazy. If you’re getting in on Apple, you know what you’re in for.
And here’s its histogram:
Taken together, that tells you Apple is a solid gainer with only moderate volatility. The three data points — RE, dScore and histogram — make sense together.
You’ll find that this is pretty true for most assets in RiskSmith — a high RE often translates to a low or moderate dScore, and a histogram skewed a bit to the green.
But things get a little kooky when you move toward assets with higher volatility.
Look at Terra ($LUNA-USD), the same example from above — first at the histogram.
A lot of cryptos look like this; statisticians call this shape “fat tails.” Basically, it just tells you that this asset takes wide swings. Most days are going to be either above +5% or below -5%. In the case of Terra, the green tail is just a bit bigger than the red tail, which is a good sign.
Given the Apple example, you’d expect this to have a pretty low RE, right? But, surprise, Terra is actually beating Apple so far in that department:
A RE of 1.94 is pretty solid! It’s only been trading for about 6 months, so we have absolutely no way to gauge its long-term performance. Safe to say, though, with a dScore over 10% and that polarized histogram, you’re in for a wild ride.
So what do we do with this information? Is the takeaway “Go all in on Terra now!”
If you’re feeling incredibly brave, be our guest — but honestly, you should have vertigo just from looking at that histogram. Those are some pretty low lows paired with the high highs.
A more realistic choice is to integrate it into your portfolio as a whole. Let’s figure out how to do that.
A risk-savvy portfolio
Now you’ve got metrics in hand that help you compare more traditional stocks with high-volatility new asset classes. It’s a toolkit that’s purpose-built for the risks of today’s investment landscape.
RiskSmith was designed to analyze a portfolio containing all these kinds of assets, and to give you the chance to calibrate the balance between high- and low-volatility components.
Once you’ve built out that portfolio, all you need to do is set its allocation to “Volatility Weighted”:
The app will automatically allocate larger positions to steadier assets, and smaller positions to riskier ones.
With these kinds of tools at your disposal, you’re armed for anything that comes your way. You can invest in anything you want — just know what you’re getting into ahead of time, and plan accordingly.