You’ve probably seen a chart that compares what $1 would have grown to if you just bought stocks and left it alone. You might also have seen the same chart showing how much worse the returns would have been if the 25 best days weren’t included. Finally, you might also have seen a similar chart which shows how much returns would have improved if the 25 worst days were avoided.
The truth is that missing the best or avoiding the worst days is impossible, but missing the best days and avoiding the worst, however, now that’s a whole different story.
Below is the 30-day standard deviation of the Dow going back to 1950. The green dots and red triangles represent the 25 best and worst days. You’ll notice two things; they all happened in periods of above average volatility (gray line), and the best and worst days tend to cluster.
The chart below shows the growth of $1 (Dow, price only). You’ll notice that buying and holding falls significantly short of a strategy that, with the benefit of a crystal ball, avoids the 25 worst days and misses the 25 best days (this does not include dividends, transaction costs, or taxes, all very important).
Why would missing the 25 best and 25 worst days do so much better? The reason is because outsized volatility is a drag on returns, so the best and worst days do not cancel each other out.
The chart below shows the hypothetical growth of $1 over 50 periods of alternating up/down performance. The gray line shows +1%, -1%, the black line shows +5%/-5%, and the red line shows +10%, -10% and so on.
$1 can alternate between 1% gains and 1% losses for a really long time before you lose any money. But alternate between +10% and -10% and after 918 times, you’re left with less than a penny.
ETFs that employ leverage are so seductive because they offer the potential for huge gains. For example, JNUG, the 3x junior gold miner bull, has closed up 10% in a day in 15% of all trading days. And even though the average daily change in JNUG is just 0.05%, after 905 trading days, it’s down 98%.
Leverage works both ways, but because investors tend to hold onto losses and sell their winners, most people in these products are likely to experience huge losses as opposed to huge gains. So be careful before you decide to purchase a 3x, or now a 4x, levered ETF.