How to Reduce Portfolio Volatility with ETFs

When choosing where to invest your money, it’s important that you don’t just lump everything into one single stock. Diversifying into different stocks across various industries can lower your risk and protect your wealth from volatility. Choosing such a wide range can be difficult, however. This where ETFs come in.

An ETF is an ‘exchange-traded fund’. Like a stock, an ETF trades on the stock market and its price will depend on how much demand there is for that particular ETF. Stocks and ETFs therefore both have volatility.

This is where it starts to get different. While a stock simply reflects the share price of a single company, an ETF can reflect entire indexes, groups of assets, or commodities.

A single piece of bad news, a botched product launch, or low revenues can dramatically impact the price of a stock. Due to the wider exposure that ETFs have, this is much less likely for them.

Stocks and volatility

As we’ve mentioned, stocks are much more prone to market movements based on a single piece of news. This is because investor confidence in a stock can plummet, meaning that there is much less demand for that particular company, leading to a much lower price.

On the flip side, one piece of good news could send a stock price soaring while the rest of the market remains generally unaffected.

As an ETF tracks the performance of an entire sector, commodity, index, or group of assets, it will not be heavily impacted by a dramatic fall or increase in one single stock (as it probably represents a small proportion of the entire holding). 

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Do ETFs provide less volatility?

The first thing to say here is that there can be no guarantees either way. On average, however, the diversity of an ETF will likely make it less volatile than a singular stock. On the other hand, if the ETF is tracking a volatile market, then you may find it being more volatile than a more secure, well-established stock.

We recommend considering each stock and ETF on their own facts and merits.