If "volatility of returns" is a measure of risk, I can illustrate some examples of why less volatile investments can be quite beneficial.

Assuming a nearly 100% equity portfolio in both cases.

Index

2006 15.64
2005 4.77
2004 10.74
2003 28.50
2002 -22.15
2001 -12.02
2000 -9.06
1999 21.07
1998 28.62
1997 33.19


consider the negative returns (-22%, -12% and -9%) in 3 consecutive years.

$1000 would have shrunk to $900 in 2000. The $900 would have shrunk to $800 the next year. Then shrunk to $620 in 2002.

That is nearly a 40% loss over 3 years. Quite volatile (relative to highs of 28-33% 3 times)

Choosing a fund which is 100% stock, but managed (so as to prevent steep losses).

returns of

2006 19.14
2005 4.26
2004 15.05
2003 25.78
2002 -13.04
2001 1.64
2000 13.12
1999 3.82
1998 9.23
1997 28.82

$1000 in 2000 would have increased to $1130 in 2000, to $1140 in 2001, then dropped to $993 in 2002. By not having the negatives, it can maintain princpal balance and still be 100% stock.

The reason for the difference in returns is the managed fund would NOT hold stocks which did not have good prospects on the way down, as well as the managed fund can buy stocks because their valuations look "cheap" based on recent stock events.

It does cost more money to not lose as much... keep in mind all returns listed (by law) are net of expenses... so the expenses are factored into the above returns.

My point is that indexing has downside risk. it is possible to invest in a portion of the index, with less risk and higher expense, and approach the returns of the index.

Over the 10 years listed above the top fund (VFINX) returned 7.55% with a high year of 33% in 1997 and low of -22% in 2002.

Over the 10 years listed, the second fund (PRFDX) returned 9.61% with a high year of 28% in 1997 and low year of -13% in 2002.

Other funds with similar styles to PRFDX (conservative equity investing, but nearly 100% equity):

DODGX (Dodge and Cox stock)
FEQTX (Fidelity Equity Income)

Examples like these are another example of being 100% stock and having less risk than someone which might be 80-20.

Downward risk/ defensive investing is a long time strategy which works for many people.