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Let’s begin with some simple math.

If you invest $100,000 and lose 10% in the first year, you’re down to $90,000. If you then gain 10% in year two, you don’t break even. You end up with $99,000. That’s a net loss of $1,000—despite an average return of zero percent.

How is this possible?

It’s because averages lie. What matters in the real world is not average return but compound return. The number that shows up on your statement at the end.

Now consider a more extreme case. You lose 50% in year one, then gain 50% in year two. Average return? Again, zero. But your ending wealth is just $75,000. That’s a devastating loss. The actual return over those two years is -13.5% per year.

These illustrative examples reflect the way volatility may chip away at real wealth.

Although technically not a tax, at Washington Crossing Advisors, we call this effect the volatility tax. And like any tax, it takes your money—quietly and persistently.

What’s Really Going On?

Here’s the mechanism: when returns are volatile—when they bounce up and down—wealth erodes. Mathematically, your compound return suffers a penalty equal to roughly half the variance of returns. This is not an accident. It’s arithmetic. And if you want the actual formula for annualized returns over time, here you go:

Regardless of the formula, what you need to know is that the more violent the swings, the greater the “volatility tax” to portfolio returns and the bigger the hit to wealth over time.

Many people misunderstand this, and maybe with good reason. Financial theory suggests that volatility and risk are things we must tolerate as the price of big returns. But what they fail to see is that unchecked volatility doesn’t just increase risk — it also imparts a substantial hit to return and wealth. And the longer the process continues, the bigger the detraction from wealth.

The Cost of Excitement

This brings us to quality. In the investing world, high-quality companies are often dismissed as dull. They have stable earnings, conservative balance sheets, and rarely make headlines. But what they lack in drama, they tend to make up for in consistency.

By contrast, low-quality companies — often touted as “value stocks” with low multiples and high dividend yields — tend to be unstable. Their earnings fluctuate. Their debts are heavy. And their stocks can take you on a roller coaster ride. The fact of the matter is that cheap stocks tend to be cheap for a reason, and that reason often centers on quality or lack thereof. Consider the charts below, we clearly see that high grade, high quality companies tend to carry higher multiples and lower yield. This is consistent with bonds, too. High quality investment grade bonds almost always carry lower yields than high yield junk bonds. Bottom line — if the market is giving you a cheap, high-yielding stock it is more than likely the case that you are looking at a lower quality issue.

It is easy to be drawn to these companies because they appear cheap. But cheapness is not the same as value. What looks like a bargain is often a trap, and the volatility tax is part of the price you pay.

The Evidence Is Clear

Over the last two decades, we’ve tracked the performance of stocks across different quality tiers—graded from “A” to “F.” What we’ve found is this: “A” and “B” quality stocks outperformed “C”, “D”, and “F” when examining compounded returns over time. This is NOT to say that high quality won out every year. High quality did not win the past couple years, for example. But over a longer time, the advantage from consistency over excitement is plain to see.

Look at the chart below. Notice that as we go down the quality scale from “A” to “F”, volatility increased. And with higher volatility the difference in returns between the average return and the compounded return is significant. This is the “volatility tax” in action. A 4.4% “tax” is levied against the high yield, high volatility “F” quality stocks and a much smaller 1.5% “tax” is levied against the lower yielding, lower volatility “A” quality stocks. This often overlooked mathematical artifact is almost always overlooked by investors, but it should not be. After all, this math reveals how capital may compound — or fail to — over time.

WCA Quality Grade Indices: December 31, 2003 – April 25, 2025

Change Afoot?

It’s easy to chase the next big thing, jaw dropping growth, or big yields. In any given year, high or low quality can rule the roost. As we noted in a recent commentary, “Quality First — The Bedrock Principle,” low-quality stocks dominated high-quality from early 2023 through early 2025. But this trend now appears to be reversing. Since February 18 of this year, as worries about tariffs began to take hold, high-quality stocks outperformed lower-quality stocks by a healthy margin (chart, below). Once again, when markets became unsettled, quality led the way.

Quality Returns Under Tariff Uncertainty: WCA Quality Grade Index Returns

There’s a saying in football: Offense wins games, but defense wins championships.

Just like football, nothing is as exciting as a completed “Hail Mary” pass for the touchdown to win the game. These are the highlight reel moments that are the attention getters and put fans in the stadium. However, one only needs to look back at the most recent Super Bowl game to understand how impactful a strong defense is to overall team performance. The World Champion Philadelphia Eagles defense overwhelmed the Kansas City Chiefs, sacking KC quarterback Patrick Mahomes six times, forcing three turnovers, and holding the Chiefs offense nearly scoreless through three quarters of the game (all while blitzing 0%).

As you can see, excitement is usually the enemy if your goal is to build lasting wealth. Consistency tends to win out in the long run. And the path to consistency lies through quality.

In a world where volatility can exact a hefty hidden tax, quality really isn’t all that dull after all.

Contacts:

Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Steve Lerit, CFA, Head of Portfolio Risk
Suzanne Ashley, Relationship Manager
Eric Needham, Sales Director
Jeff Battipaglia, Sales and Marketing
(973) 549-4168

www.washingtoncrossingadvisors.com

Disclosures:

WCA Barometer – We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. Analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.

Standard & Poor’s 500 Index (S&P 500) is a capitalization-weighted index that is generally considered representative of the U.S. large capitalization market.

S&P Global (SPGI) is a leading American provider of financial information, analytics, and credit ratings, headquartered in New York, NY. It operates major divisions including S&P Global Ratings, S&P Global Market Intelligence, S&P Global Commodity Insights, S&P Global Mobility, and S&P Dow Jones Indices.

The ICE BofA U.S. High Yield Index is an unmanaged index that tracks the performance of U.S. dollar denominated, below investment-grade rated corporate debt publicly issued in the U.S. domestic market.

The S&P 500 Growth measures constituents from the S&P 500 that are classified as growth stocks based on three factors: sales growth, the ratio of earnings change to price, and momentum.

The S&P 500 Value Index measures constituents from the S&P 500 that are classified as value stocks based on three factors: the ratios of book value, earnings and sales to price.

The S&P 500 Equal Weight Index is the equal-weight version of the widely regarded Standard & Poor’s 500 Index, which is generally considered representative of the U.S. large capitalization market. The index has the same constituents as the capitalization-weighted S&P 500, but each company in the index is allocated a fixed weight of 0.20% at each quarterly rebalancing.

The WCA Rising Dividend Custom Benchmark is a rules-based benchmark constructed by Washington Crossing Advisors to represent a universe of large capitalization U.S. companies that meet certain quality and dividend growth criteria, including proprietary screens for profitability, earnings consistency, and balance sheet strength, along with minimum market capitalization and dividend growth requirements. The benchmark is reconstituted and rebalanced quarterly and is intended to serve as a style-appropriate benchmark for the WCA Rising Dividend strategy.

The Washington Crossing Advisors’ High Quality Index and Low Quality Index are objective, quantitative measures designed to identify quality in the top 1,000 U.S. companies. Ranked by fundamental factors, WCA grades companies from “A” (top quintile) to “F” (bottom quintile). Factors include debt relative to equity, asset profitability, and consistency in performance. Companies with lower debt, higher profitability, and greater consistency earn higher grades. These indices are reconstituted annually and rebalanced daily. For informational purposes only, and WCA Quality Grade indices do not reflect the performance of any WCA investment strategy.

The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains.

The information contained herein has been prepared from sources believed to be reliable but is not guaranteed by us and is not a complete summary or statement of all available data, nor is it considered an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. There is no guarantee that the figures or opinions forecast in this report will be realized or achieved. Employees of Stifel, Nicolaus & Company, Incorporated or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within. Past performance is no guarantee of future results. Indices are unmanaged, and you cannot invest directly in an index.

Asset allocation and diversification do not ensure a profit and may not protect against loss. There are special considerations associated with international investing, including the risk of currency fluctuations and political and economic events. Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments. Investing in emerging markets may involve greater risk and volatility than investing in more developed countries. Due to their narrow focus, sector-based investments typically exhibit greater volatility. Small-company stocks are typically more volatile and carry additional risks since smaller companies generally are not as well established as larger companies. Property values can fall due to environmental, economic, or other reasons, and changes in interest rates can negatively impact the performance of real estate companies. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. High-yield bonds have greater credit risk than higher-quality bonds. Bond laddering does not assure a profit or protect against loss in a declining market. The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains. Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments.

All investments involve risk, including loss of principal, and there is no guarantee that investment objectives will be met. It is important to review your investment objectives, risk tolerance, and liquidity needs before choosing an investment style or manager. Equity investments are subject generally to market, market sector, market liquidity, issuer, and investment style risks, among other factors to varying degrees. Fixed Income investments are subject to market, market liquidity, issuer, investment style, interest rate, credit quality, and call risks, among other factors to varying degrees.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio relative to the market as a whole. A beta of one is considered as risky as the benchmark and is therefore likely to provide expected returns approximate to those of the benchmark during both up and down periods. A portfolio with a beta of two would move approximately twice as much as the benchmark.

Standard deviation is a measure of the volatility of a security’s or portfolio’s returns in relation to the mean return. The larger the standard deviation, the greater the volatility of return in relation to the mean return.

Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments

This commentary often expresses opinions about the direction of market, investment sector, and other trends. The opinions should not be considered predictions of future results. The information contained in this report is based on sources believed to be reliable, but is not guaranteed and not necessarily complete.

The securities discussed in this material were selected due to recent changes in the strategies. This selection criterion is not based on any measurement of performance of the underlying security.

Washington Crossing Advisors, LLC is a wholly-owned subsidiary and affiliated SEC Registered Investment Adviser of Stifel Financial Corp (NYSE: SF). Registration with the SEC implies no level of sophistication in investment management.