Long-term investors must live with volatility even though it spooks many of them, sometimes leading to irrational decisions. But learning to live with volatility is the price he or she must pay.

Why?

The same forces that drive up stock prices quickly are what drive them down quickly. And since it is seemingly impossible to predict when markets will head north or south quickly, the long-term investor must tolerate volatility. That’s because the stoic long-term investor is paid with fat returns in good times since he or she held on for a rocky ride in bad times. Live with it.

Such is conventional investing wisdom accepted by many market players and advisors. They argue or implicitly accept that the market force that drives up stocks—volatility—is the same force that drives them down. However, this is the kind of talk that spooks investors, leading some to exit markets. And that is one reason many can’t stick to a long-term financial plan. So today many are carrying a lot of cash, a decision that will likely drag down their returns. (See sidebar, “Cash Is Gold for Many Investors.”)

But the long-term investor, if properly educated, can live with and even prosper from volatility. This is the argument of the supporters of the low-volatility investing (“Low Vol”) strategy. They have constructed the S&P 500 Low Volatility Index. They contend that, while volatility is not avoidable, it can be managed and limited. This is what they call the low vol anomaly. Supporters of the strategy say it can, and has, worked.

“When the S&P 500’s volatility rises [as in 2002 or 2008], the S&P 500 Low Volatility has also tended to be more volatile, but its volatility is consistently lower than the S&P 500,” according to the S&P Dow Indices paper, “Is the Low Volatility Anomaly Universal?”

Supporters of this smart beta strategy argue that there is “a low volatility anomaly” that has been around for decades. This strategy provides an investor with most of the upside in bull markets, but avoids much of the damage in bear markets.

One buys certain stocks with reduced standard deviation and that can reduce losses in bear markets.

Alex Bryan, an analyst with Morningstar who recently analyzed Low Vol, called it a decent strategy for the risk-averse, and he is a qualified supporter. He notes that the Low Vol index is only some four years old and needs to be tested in a deep bear market. Still, he says the data tends to support the strategy. In a recent analysis, he agrees that Low Vol can miss some of the upside, but it still offers a good investment option for bear markets.

“Low vol is not a perfect measure of risk,” he wrote, “but it is worth heeding because it is directionally related to the probability of large losses.

“Stocks with low vol tend to hold up better during market downturns than those with high vol,” he added.

The S&P Dow Jones Indices paper concludes that the “evidence that low volatility persists, at least in the short to medium term, is strong.”

However, critics challenge the evidence. They argue that Low Vol backers have picked a good period to support their case, while not including others that compromise their case.

What is the evidence?

The S&P Dow Jones Indices paper reviewed 291 months in the period between 1991 and the first quarter of this year. The low volatility index outperformed the S&P Large Cap by 101 out of the 291 months, according to study. Those were the months the S&P 500 declined.

In the 50 months in which the S&P declined the most, the S&P Volatility Index outperformed it by an average of 2.89%. In the other 51 months, in which there were smaller drops, the S&P was outperformed by Low Vol by an average of 0.81%.

The bigger the losses in the market in any given month, Low Vol proponents argue, the more this strategy outperforms the S&P 500. However, they accept a sacrifice in upside returns. For example, in the S&P’s 95 best months—when it was charging up an average of 5.11% a month, the low volatility index lagged the standard benchmark by 1.73%.

“The S&P 500 Low Volatility Index,” the study said, “tends to rise less than when the market is up, and tends to decline less than the market when the market is down—and that’s why overall volatility is lower than that of the S&P 500.”

S&P Dow Jones Indices officials say their reductions in volatility have been found across various equity categories from a quarter century of data. They say the greatest index volatility reductions have been seen in emerging markets. The strategy, they add, can be an effective tool for many financial advisors.

“I had advisors coming to me a few years ago saying that they were looking for a money preservation strategy,” says Craig Lazzara, managing director, Index Investment Strategy at S&P Dow Jones Indices. He says that adopting this strategy is appropriate for advisors with considerable assets. The advisor, he adds, can bring clients through bad times with below-average losses and still be in a position to reap most of the gains from bull markets.

Then there is the low vol anomaly. From 1968 to 2013, Morningstar’s Alex Bryan notes in a recent report, “the least volatile fifth of the U.S. market actually offered higher returns than the most volatile fifth.”

The debate over why this is, Lazzara adds, has been going on for over 40 years. The anomaly effect was noticed in 1972 by Fischer Black, Michael Jensen and Myron Scholes. Other researchers have since found supporting evidence.

Still, critics contend investors seeking less risk should just buy a few more bonds or perhaps some balanced stocks. And, in a recent paper, two Low Vol dissenters warned that history is not clearly on the side of this supposed low-risk approach.

“What seems to attract investors … is that this lower volatility did not come at the cost of lower returns, at least from 1970 to 2013. However, from 1929 to 1969, returns and volatility were positively related,” according to Bhanu Singh and Marlena Lee, researchers with Dimensional Fund Advisors. In other words, you still need to endure that volatility for better performance.

In their recent paper, “Smart Beta,” the DFA analysts criticize the Low Vol strategy as lacking consistency—that it is, in fact, an inconsistent form of value investing. “The historical record shows that low volatility strategies sometimes emphasize value and sometimes do not,” they write.

“This style drift should not be surprising, given that the low volatility strategy was not designed with valuation in mind.” Singh and Lee warn that investors shouldn’t expect the Low Vol anomaly to be “continuously positioned to capture these premiums.”

But Low Vol advocates contend that theirs is a low cost/low risk approach. With value investments, one buys on the cheap so, when stocks head south, the investor isn’t hurt as much.

What are these low cost buys?

Stocks in the index tend to be consumer staples. They are companies offering products that people usually buy even when the country is in recession or when markets are reeling or both. So while these companies also go through hard times along with the rest of the market, they don’t shed as much blood. Altria Group, Walmart, Colgate-Palmolive, McDonald’s Corp. and Procter & Gamble are among such companies.

How Has Low Vol Done in 2015?
This year the evidence is mixed. Sometimes low volatility indexes have beaten the standard index. Sometimes they haven’t.

But Lazzara says that’s not surprising. Despite some rough times, the S&P hasn’t been down that much this year. “The test of low vol investing is in the really bad years. For instance in 2008, when the S&P was down 37%, the low vol index was only down 22%.”

He adds that “low vol investing will smooth out returns. It attenuates them. You will not go down and up as much.”

Still, John Rekenthaler, another Morningstar analyst, cautions that there are still questions about low vol. In a recent commentary, he argued that standard deviation is only one way to measure risk. Another way is to use tail risk. That looks at how a fund performs in extreme conditions.

The means investors should also use another metric, called “excess conditional value-at-risk,” or “ECVaR,” which evaluates how a fund behaves during sharp downturns. This measures whether a fund suffers particularly bad results when stocks are plummeting, he argues.

“If ECVaR is used to calculate risk rather than standard deviation, mutual fund results line up according to standard investment theory,” Rekenthaler writes in a commentary. “That is, the lowest-risk funds as measured by ECVaR have the weakest future returns, and the highest-risk funds have the best. This holds true for both U.S. and foreign equities.”

Who should one believe and how should an advisor cope with a force of nature called volatility that can’t be avoided by anyone fully invested over long periods?

Maybe the best answer is no answer. Investors should just stay fully invested through good times and bad. That’s an option one might have well considered during the height of the volatile market this year.

“What to do during market volatility? Perhaps nothing,” advised Bill McNabb, chairman and CEO of Vanguard Funds in a recent advisory. “Often the wisest thing to do during periods of extreme market volatility is to stick with an investment plan.”