Volatility Drives Us Mad and Steals Our Future

Five years ago this week, one of the wildest times in the market I’ve seen in my entire career on The Street. The daily swings, driven by headlines and comments from European bankers and politicians, were breathtaking.

The Wall Street Journal from today in 2011:

The market’s volatility benchmark has seldom been so, well, volatile.

The CBOE Market Volatility Index, or VIX, rose 26% to close at 42.99 as U.S. stocks sank after investors cast a wary eye at European banks and digested an increasingly dour outlook for U.S. economic growth.

The VIX, which tracks the price investors pay for protective options on the Standard & Poor’s 500 stock index, has had a frantic run during the wild stock swings of recent days. The VIX closed at 48 Monday, a 29-month high, then staged at 27% retreat Tuesday, its second-biggest one-day drop on record. The VIX finished with its third-consecutive session with a move greater than 20%, a streak with only one precedent: the May 2010 “flash crash.”

If you weren’t in the game or don’t remember, believe me when I tell you that it was absolutely bananas.

Investors, including some professionals, reacted to this volatility in the usual way that fall: Subscribing to alerts products from guru traders and economists, bidding up gold, fleeing to cash and pouring money into “Black Swan” products or counterproductive hedges that cost more money than they protect.

No one’s perfect. It’s totally understandable to be afraid when 2% swings in the daily value of our portfolios become the norm.

That episode in the markets set us up for a nearly uninterrupted, incredible bull run that’s been going on for five years now. Being in for the torture of 2011 was us, the investor class, paying our dues.

The question is, have we learned anything? I suspect many have, but may still be prone to repeat the errors of 2011 during the next bout of incredible vol (it will happen again, I assure you).

In case the lessons have been forgotten, I wanted to share with you an incredible data point from a new post by my colleague Michael Batnick. With an assist from the estimable Jeffrey Ptak of Morningstar, Michael calculates how much money investors left on the table by fretting over the ubiquitous “double-dip recession” calls of the recovery period.

The S&P 500 is now up 270% from the lows made in March 2009, but how many people were actually able to harvest those gains? In the 89 months since the market bottomed, investors have had had a barrage of distractions thrown at them. From the Sequestration to the Fiscal Cliff and from China to Greece, walls of worry seemed to just blur into one another. And unfortunately, many investors allowed these fears to drive their decisions. Since March 2009, the largest S&P 500 ETF, SPY, grew at an annualized 18.08%. But over that time, investors in SPY earned just an annualized 11.82%*. The difference between 18.08% and 11.82% over 7.5 years is a whopping 115%!

Michael goes on to discuss just how incredibly distracting these repeated double-dip recession calls have been. I urge you to get over there and read the hell out of it. Then send it your financial advisor or your misinformed friends. They will benefit from re-learning this lesson just as I have. Every one of us is human and we all require reinforcement in good times and bad to avoid repeating mistakes.

Go here:

Distractions Cost Investors 115% (The Irrelevant Investor)