Volatility Management and Wealth Creation: A Long-Term Perspective

Abstract

Investors may not understand the wealth-destroying implications of their investment decisions, because of the deleterious effect of volatility of returns on wealth creation. Managing the volatility of returns is integral to creating long-term wealth. The methodology presented quantifies the single-period risk-and-return tradeoff that investors need to be aware of to create long-term wealth. Practitioners can use it as a tool to educate clients about the wealth-creating benefits of diversification. Economic sector return data is used to demonstrate that underdiversified portfolios, as opposed to diversified portfolios, inhibit long-term wealth creation, because of the volatility drag associated with underdiversified portfolios.