Low Volatility Investing FAQ: Volatility, Beta and Variance

This question-and-answer page explains the basic ideas behind low volatility investing. It is educational only and is not financial advice.

What does a volatility number mean?

Volatility is one way of measuring how risky a stock is. It reflects how large, and how frequent, price changes have been over a chosen period. A portfolio full of highly volatile stocks can swing sharply. When markets fall, such stocks may drop hard, whereas calmer ones tend to keep more of their value. Supporters of the approach argue that protecting capital in bad markets can improve long-run results.

How is it calculated?

The site used the standard deviation of monthly returns over two years. You take each of the previous 24 monthly returns, find its distance from the average, square those distances, add them up and divide by the number of observations minus one. Under a normal distribution, about two thirds of observations lie within one standard deviation of the mean.

Variance versus volatility

Both measure risk and are tightly linked. Variance is simply volatility squared.

Beta versus volatility

Beta is a different risk measure. It shows how sensitive a stock is to market moves. Mathematically it is the covariance between the stock’s returns and the market’s returns, divided by the variance of the market’s returns: beta = Cov(r_i, r_m) / Var(r_m). Equivalently, beta = correlation × (σ_i / σ_m), where σ_i and σ_m are the standard deviations of the stock and the market.

Why does this contradict what business schools teach?

A 2012 paper by Nardin Baker and Robert Haugen addresses the puzzle in depth. The site hosted it for free download from its homepage.

Do low volatility stocks always win?

According to the research cited, over periods longer than five years the least volatile stocks have outperformed riskier ones, in every market studied, in data from 1926 through 2011. The exceptions were short, intense bull markets such as the dot-com bubble, which Alan Greenspan described as “irrational exuberance”. The research also suggests that trading no more often than quarterly beats a monthly schedule.

Why are some stocks left out?

Very small stocks and those that rarely trade give a poor picture of true volatility. A stock also needed at least two years of price history to be ranked.

Why quarterly rather than monthly?

The underlying studies found that frequent trading adds costs and noise without improving returns. Holding positions for a full quarter before rebalancing kept turnover down while still capturing the pattern researchers observed. Individual circumstances differ, so this is a research observation and not a recommendation.

Privacy

The site said that email addresses were used only to announce new reports, tools and information about the anomaly, and that personal data would not be sold or shared without permission.

Updates

The monthly ranking reports were refreshed on the first day of each month, and the site said it planned interactive tools for studying how each holding, and the portfolio as a whole, behaves. See the glossary for more terms.