A trader works inside a booth on the floor at the New York Stock Exchange (NYSE) in November, 2025. The sprawling U.S. software sector suffered a US$300-billion hit this week.Brendan McDermid/Reuters
What’s happening to investors’ favourite havens? Gold and silver, the traditional refuges for monetary pessimists, have endured a wild couple of weeks. Bitcoin has been declining for months and even the mighty U.S. dollar has been leaking value against a basket of other currencies.
Things look better if you focus on the stock market, but there, too, the volatility in some areas has been vicious. The sprawling U.S. software sector, usually a steady spinner of wealth, suffered a US$300-billion hit this week after Anthropic PBC unveiled new artificial-intelligence tools that could potentially supplant a wide swath of existing software products. Even the Magnificent Seven stocks are showing signs of strain, with Amazon.com Inc., Microsoft Corp. and Tesla Inc. losing value since the start of the year.
If all this turbulence is causing you stress, it may be a good time to ask how much risk you really want in your portfolio.
It is not an easy question. Risk is difficult to assess and even more difficult to avoid. More confusingly still, there are two main lines of thought about how to dial down risk and they pull in different directions.
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The first approach emphasizes choosing investments that are stable, dependable and low in volatility.
The second approach leans the other way and suggests embracing volatility, but by choosing an array of investments that tend to move in opposite, or at least uncorrelated, directions.
Both strategies can work, but both have their limits because each is based on historical relationships that may or may not hold up under stress. Buying low-risk assets, for instance, is a strategy that works splendidly right up until it doesn’t. In times of upheaval, supposedly ultrasafe assets can abruptly turn treacherous – as bank stocks did during the 2008 global financial crisis.
Similarly, long-standing correlations among assets can suddenly shift, surprising investors who were counting on gains in one area to counterbalance losses in another. One painful example came in 2022, when the time-honoured relationship between stocks and bonds broke down. For decades, the two assets had tended to move in opposite directions, with bonds prospering when stocks suffered. However, in 2022, both assets took a beating.
If there is a lesson to be learned from such episodes, it’s that many risks are impossible to foresee. Over the past 25 years, the global economy has been hit by the 9/11 attacks in 2001, a financial meltdown in 2008, the start of the COVID-19 pandemic in 2020 and a big burst of inflation in 2022. The thing that’s most surprising about world-shaking surprises is just how frequent they actually are.
You can’t avoid surprises but you can choose how much they are likely to affect you. A good place to start is by being realistic about the potential for losses, especially when it comes to stocks.
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Jonathan Clements, the late, great financial writer, recommended that investors periodically ask themselves if their lives would be disrupted if the value of their stocks suddenly fell by 35 per cent – which is the amount that stocks typically lose during a serious bear market. If you’re not prepared to endure such a hit once every few years, you should prune your stock holdings in favour of more stable investments such as bonds.
Can you reduce the risk inherent in stocks with exotic option strategies or bold bets on underappreciated assets? Sadly, the evidence suggests not. Hedge funds – which, as their name suggests, are all about hedging risks – typically underperform simple index funds over the long haul, despite their use of sophisticated hedging strategies.
Warren Buffett illustrated the limits of hedging in 2008 when he entered into a US$1-million bet with Ted Seides, a prominent hedge fund adviser. The billionaire investor, a long-time critic of the money management industry, wagered that a cheap S&P 500 index fund would beat Mr. Seides’s hand-picked selection of five top hedge funds over the next decade.
And so it did. In fact, the index fund was so far ahead by the end of 2016 that Mr. Buffett and Mr. Seides agreed to wind up their bet a year early. If the Buffett bet is anything to judge by, many sophisticated hedging strategies don’t actually deliver much in the way of real-world results.
Investors who want to dial down risk might want to turn instead to simple, everyday tactics.
One is to dump high-fee investments. In most cases, mutual funds and exchange-traded funds with lower fees do better than their more expensive counterparts for the simple reason that more of the profits wind up in your pocket.
Another good tactic is to embrace diversification. If your portfolio is centred on just one industry, or just one country, or just one asset it will probably be less stable than a more widely diversified portfolio. (The good news here is that you can achieve instant, low-cost diversification simply by buying a balanced exchange-traded fund such as Vanguard Canada’s VBAL or iShares’ XBAL.)
A final tactic is to follow Mr. Clements’s advice and calibrate your stock holdings to how much pain you can endure. Stocks typically suffer a 20-per-cent or greater fall once every 5.2 years and a 30-per-cent or greater decline once every 8.9 years, according to Man Group. If those numbers give you shivers, it’s time to dial down your stock holdings.