What’s Riskier Than the Riskiest Stocks?

imagesAny seasoned investor will tell you that buying one stock is riskier than buying a basket of stocks. The underlying concept is diversification—the idea that the movement of the shares of many different companies, taken together, will be smoother than the trajectory of any one of them.

But the ETF market has managed to create composite securities that are even more volatile than individual stocks.

A recent article in Investment News looks at the most volatile individual stock in the S&P 500—First Solar—which has a standard deviation of 66.02. That means its jumps up or down tend to be almost exactly 6 times higher than the S&P 500.

That’s pretty wild, but not as wild as the ProShares Ultra VIX Short-term Futures Fund, an ETF with a 3-year standard deviation that is twice as high as First Solar’s: 132.9. Imagine that the markets go up or down 2% in one day, and you’re looking at 24% price movements.

 

Those wild swings are not serving you. If the markets go down 24% (gloom!) and then rise 24% the next day (euphoria!), you’re looking at a 5.76% loss for the two day period. Why? It takes a 31.6% return to recover from a 24% loss.

The ProShares fund is not the only leveraged ETF that threatens to multiply your portfolio volatility. The Direxion Daily Gold Miners Bear 3x ETF sports a 3-year standard deviation of 125.45. A more popular investment, which Bloomberg recently listed as one of the top 10 traded funds by Millennials in 2015, is the triply-leveraged VelocityShares Daily 3x Long Crude ETN. It has a three year standard deviation of “just” 85.89, still higher than the most volatile S&P 500 stock, still nearly eight times higher than the index itself. The crude oil fund has lost an average of 82.67% a year in the last three years, turning a $10,000 investment into $52.01.

 

The lesson? ETFs were created originally as less expensive, more easily traded alternatives to index mutual funds, providing diversification with low drag on returns. But the concept has been used—some would say misused—to create exotic instruments that are even more dangerous to your financial health than betting all your money on a single, volatile stock. The SEC is mulling whether to shut down the most highly-leveraged ETFs, which would have prevented Millennials from experiencing losses by betting on energy prices. Most of us can just regulate ourselves, and steer clear of the most volatile investments ever dreamed up by creative marketers.

Sources:

http://www.investmentnews.com/article/20160224/FREE/160229975/think-your-stock-fund-is-risky-try-these-etfs?utm_campaign=socialflow&utm_source=twitter&utm_medium=social

http://www.bloomberg.com/news/articles/2016-02-19/millennials-are-using-one-of-the-riskiest-etfs-to-speculate-on-oil

 

About Objectively Speaking

Tom Batterman, founder of Vigil Trust & Financial Advocacy and Financial Fiduciaries, LLC is in the business of representing the best financial interests of his clients. Having provided objective, fee-only financial management services for over two decades, he specializes in managing the investment and related financial affairs of individuals and mutual insurance companies who do not have the time, interest or expertise to manage such matters on their own. As an objective, unbiased professional who takes on a fiduciary responsibility to his clients, he guides clients to the financial decisions they would make themselves if they had years of training and experience and the time and expertise to fully research and understand all of their options. Founded in 2010 as an outgrowth of Vigil Trust & Financial Advocacy, Financial Fiduciaries, LLC is a financial management solution for individuals and mutual insurance companies who recognize they do not have the time, interest or expertise to properly attend to their financial matters on their own. While there are many financial “advisors”, most of them have investment products to sell and the “advice” they provide is geared toward getting their clients to engage in a purchase. As one of the rare subset of advisors known as “fiduciary advisors”, Financial Fiduciaries does not sell any investment product so its guidance is not compromised by conflicts of interest which plague ordinary advisors. Prior to his employment in the financial industry in financial advocacy and trust positions, he worked at a private law practice in the Wausau area in the areas of estate planning, tax, retirement planning, corporate organizations and real estate. He is a graduate of the University of Wisconsin-Madison and the UW-Madison Law School and has during his career held Series 7, 24 and 65 securities licenses. A longtime resident of the Wausau, Wisconsin Area, Tom is active in the community. He enjoys golf, curling, skiing, fishing, traveling and spending time with his family.
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