Price volatility hasn’t been much of a concern lately for most investors in U.S. stocks. History strongly suggests they shouldn’t get used to that.  The biggest danger of ignoring history, of course, is that investors might get complacent, convinced that the smooth ride will continue. They might take on more risk in their portfolios than they would be comfortable with when volatility kicks in again—and then sell in a panic when prices are dropping sharply.  That’s clearly not the portfolio strategy most financial advisers recommend, which is to put together a portfolio that reflects your long-term financial goals and your risk tolerance and stick with it through thick and thin.  To avoid complacency, investors would be advised to look at the numbers. The average annual return of the S&P 500 index since 1970 is 12%, not compounded. But the market has been so volatile over that stretch that returns for any given year usually haven’t been close to that number.  In fact, the S&P 500 has produced a calendar-year return between 10% and 14%—or within two percentage points of the 12% average—only four times in the 45 years from 1970 through 2014. Only eight times in that period has the calendar-year return come within four percentage points of the average, or between 8% and 16%.  At the extremes, the index has posted returns of 30% or more in eight of those 45 years, and losses in nine years, including five double-digit downturns, the biggest being 2008’s 37% plunge.  Another measure of volatility is standard deviation. For the S&P 500, the standard deviation since 1970 is around 17. That means it takes a range of 17 percentage points on either side of the average to encompass most of the individual annual returns—or from 29% to negative 5%.  Over the past few years, though, the market has been strong and volatility low. Indeed, late last year the Sharpe ratio, a measure of return per unit of volatility, reached its highest level of the past 35 years, wrote Brian Portnoy, director of investment education at Virtus Investment Partners Inc., VRTS -3.91 % in a recent analysis.  The average Sharpe ratio for the S&P 500 index since 1980, based on a rolling three-year measure of returns and volatility, is 0.58, Mr. Portnoy wrote, and the ratio has rarely climbed above 1.0 in that period. But it reached a peak for the 35 years at 2.18 in November. In his analysis, Mr. Portnoy wrote that “risk-adjusted returns for investing in U.S. large-cap stocks have never been higher in most of our investing lifetimes.”  In other words, the situation is perfect for complacency.  One option for investors who are looking to cushion their portfolios from future bouts of volatility is dividend stocks, which have exhibited slightly lower volatility than the overall market in recent years.  For instance, one dividend-oriented mutual fund with lower volatility than the S&P 500 index over the past 15 years is the Vanguard Dividend Growth fund (VDIGX). The standard deviation of this fund’s returns for the 15 years through the end of March is 12.86—its returns for each of those 15 years have fallen within 12.86 percentage points on either side its average annual return for the period. The standard deviation for the S&P 500 over the same period is 15.09.  And Vanguard Dividend Growth’s 6% annualized return over the 15 years has exceeded the index’s 4.15% annualized return.  Bonds have done an even better job than dividend stocks of tamping down volatility. For example, the standard deviation of the Barclays U.S. Aggregate Bond Index is 3.52 for the 15 years through the end of March. The index’s annualized return for the 15 years was 5.66%.  Of course, it’s up to individual investors to decide what level of risk is appropriate for them, given their financial goals, and how much volatility they can stomach. Standard deviations and Sharpe ratios for various investments are available on many investment websites.  Mr. Coumarianos is a writer in Laguna Hills, Calif. He can be reached at reports@wsj.com.
Big U.S. stocks have given investors a remarkably smooth ride in recent years. That might lull some into complacency about the risk in their portfolios.