Losing Money in a Volatile Market

A re-post as STUMP revives

Howdy all … STUMP is only partly back, with pretty much all the links there broken.

In the interim, I’m going to be reposting some posts, as I can get at either the google cache or my database code.

The post below is originally from March 16, 2020, and so the data are 10 days out of date. I will be doing a subsequent post, as it relates to public pensions and their assets.

Some advice: beware volatility

I have been seeing various people talking about buying (and selling) in the current market.

My general advice is: DON'T.

Now, there are lots of outs to that advice, and the main out is if you've done this before. And you are able to suck it up if you lose a lot of money.

I'm going to grab some recent market data from Yahoo Finance [up to 3/16/20]- just the S&P 500, and rather than looking at it minute-by-minute, we'll look at the open, close, high, and low by each day.

OPEN-HIGH-LOW-CLOSE CHART FOR FEBRUARY THROUGH MARCH 16, 2020

Before I start calculating trades, let's take a look at the roller coaster ride going back to the beginning of February. I'm not going to explain the chart - you can see an explanation here.

We need to know only one thing: that the index level reached every level on the line segment shown at some point in the day [the rectangle is from the open & close]. I don't like how Excel has implemented these charts, but I'm not messing with something fancier right now.

Also, I made the vertical scale logarithmic (scale of 2). Just so it looks right to me. I hate linear scales for stock movements. I want to be able to "see" percentage differences.

So we've had quite a ride on the stock market the last couple weeks [up to March 16]. Let us posit a theoretical investor, how has invested in an S&P500 index fund, and has been enjoying gains for years.

And then.... this!

FIRST TRADE: PANICKED SELLING

Let us suppose our theoretical investor sees that first slide and then freaks out, and sells...

Oh no!

That's selling at the low point on 2/28 at 2855.84 for the index. [We'll get back to that in a bit]

SECOND TRADE: PANICKED BUYING

So this person is sitting out, but sees the relatively large run-up in the next week... and buys at the top of the run: at 3130.97 on 3/4.

LAST TRADE: SELLING AGAIN

Ah, but the market has dropped again., and our theoretical investor has once again panicked and wants out of the market for good:

So now they've sold again, this time at the low on 3/13 — 2492.37.

What has been the net change in their asset value?

DOING THE MATH

That first cash out... well, I'm going to make it simple. Let's suppose we're buying "shares" of stock that have the index price. Also, I'm switching from "theoretical investor" to me, just to simplify all the noun usage. Because I would never do the following:

Let's say I had 100 shares to begin with that I sold on 2/28 at the low, I would have exactly $285,584 when I cashed out from that first trade (I'm pretending all these buy/sell transactions are frictionless, but we'll get back to that at the end).

Okay, when we buy at 3130.97 on 3/4, then my $285,584 goes into $285,584/3130.97 = 91.21 shares. So I haven't exactly lost wealth per se, but I went from having 100 shares down to 91 shares... if I had just have held onto my 100 shares, I would have had $313,097 in asset value on 3/4 and not $285,584. But no matter.

So when I sell my 91.21 shares on 3/13, now I have 91.21*2492.37 = $227,336 [yes, I'm doing some rounding]

So.... how much money did that theoretical investor lose if they did all these trades?

The easiest loss to see is going from $285,584 in cash down to $227,336 in cash. That's a loss of $58,248. That's substantial - a 20% loss over that period.

However, there's some perspective missing here.

WHERE DID YOU START AND WHERE WILL YOU END?

I didn't mention as to when this theoretical investor, me, had originally invested to buy the 100 shares.

To make it simple, let us suppose it was ten years ago -- March 1, 2010. The S&P was at $1,169.43 according to Yahoo Finance... so to buy 100 "shares", would have been $116,943.

With the trades mentioned above, the $116,943 in cash has been transformed into $227,336 in cash. That's a cumulative increase of 94%, and that's about a 6.87% per year return, compounded.

If one had not done those trades, on 3/16, where the market closed at 2,386.13, one would have been slightly better off, $238,613, a cumulative increase of 104%, and about a 7.39% per year return, compounded.

By those trades during a volatile period, I would have hurt my cumulative return by a 10 percentage point difference. 94% versus 104%. And that's just for doing a couple of trades over a couple of weeks!

People can get really caught up in the frenzy of the moment, and trading while values are fluctuating wildly can lead to locking in losses and missing recoveries. If you are a long-term investor, like me - meaning I don't need to draw on my investments for income for decades - then it is a huge mistake to make trades during a volatile period of the market. You are likely to get burned.

REALISM: TRANSACTION COSTS AND EMOTIONAL REACTIONS

I mentioned I made the above frictionless, so no percentage was taken off for each trade. But imagine if there were a financial transactions tax, as many progressives like to tout. You could get screwed even more by each trade you make. [Later, a friend pointed out I also ignored capital gains taxes… and I certainly don’t want to throw that in right now.]

But the main thing is that many people get emotionally caught up in the roller coaster ride, and it is almost definitely going to make your investment results worse if you decide on trades that way. This has long been known in the financial community.

It is really tough to manage through this sort of time.

I may have mentioned this to y'all before, but I don't look at my investments more often than once a year. On tax day (though I've done taxes months before), I look at my retirement account allocations, decide if that's where it should be for my age and family situation (and taking into account other assets I have that are real estate - my house - or other stuff - my permanent life insurance policy, for instance, which I have as a guaranteed amount at my death, or possibly higher as it gets dividends), and adjust and rebalance if need be.

[Note: as tax day has been put off till July 15, and as there’s still a lot of volatility, I’m still not going to look at my investments for some months.]

That's it.

I do check on the funds I'm in, to make sure the fees are reasonable, but seriously, I let it ride. I don't have time to do active investing, and I know I can lose a lot of money if I did active investing. It's not for me.

KNOW THYSELF

It's so funny that often old advice works so well in so many situations.

There is the old motto from Delphi, and used in so many situations: Know Thyself.

You need to know your limitations when it comes to various activities. I know I cannot stomach short-selling or day-trading... but some people can do it. Just not me.

I'm a believer in a very weak form of the efficient market hypothesis: I (that is: me, Mary Pat Campbell), cannot beat the market. So I don't bother. I focus on my long-term financial goals, which involve setting up my son (who is cognitively disabled) for life after Stu & I are gone and retirement income once I'm unable to work.

Trying to trade during an extremely volatile period of the market does not have a good connection to my goals. So I don't do it.

I recommend you not do it, either, if you're like me.

If you're not like me, and you think you can do it -- well, maybe you can. I don't know. I just know that I cannot.

Postscript: Since March 16

You may wonder what the market has been up to since my writing above. Here is a snapshot from Yahoo Finance:

Just eyeballing it, there were additional chances to lose even more money in the market volatility, so I don’t feel like adding what I had said above.

Of course, if you’ve already traded… well, I’m sorry to hear that [unless you’ve successfully maneuvered through it, and congrats].

But you’re alive to read this, so…. yay!

Take your celebrations where you can!