My friends Tesla just taught me about market volatility.
On Saturday morning, my buddy picked me up in his new Tesla.
I’m not a car guy. I enjoy driving only on the backroads of upper Michigan during the summer.
But I have to admit that the Tesla is a pretty fantastic automobile. The middle screen has all sorts of fancy info that other cars do not have yet. Although, I am not sure if having cameras shooting information from all sides of the car make any difference. But thanks anyway, Elon!
I appreciated how quieter the interior was and, of course, the car’s speed was incredible.
Several times when we hit the gas, I mean battery, the car accelerated very quickly. I haven’t been in a car that can go from zero to sixty in close to three seconds in a long time.
Acceleration is part fun and part fear for humans. But there is no doubt that our biological risk management system sends us a message that speed and acceleration is dangerous. I grabbed the armrests and felt my stomach turn when the car flew from zero to sixty in no time.
Our minds know that if we hit something at high speeds, we are finished. Think about how risky a space shuttle launch is!
Last night, when I had time to relax and the multiple gin and tonics finally almost exited my body from the night before, I started to think about the speed of stock market losses.
Stock market volatility kills
Speed kills and the pace of your stock portfolio drawdown matters.
The COVID stock market collapse in March of 2020 was rapid and brutal. In a matter of weeks, the portfolio was down close to 30 percent. We do not like to see losses rapidly accelerating, no different than we like to be hurled forward in Tesla unless we have proper safety mechanisms in place.
The speed and acceleration make our stomachs churn and we cannot ignore the worry that maybe the next down day will be another five percent. The losses are too rapid.
In 2022, the descent has been much slower, but still a sizeable loss to investors was there. I can’t say why for sure, but slow versus rapid losses matter. Maybe slow declines are easier for the mind to handle even if the ultimate loss of wealth is the same. Our risk mechanism and framing is not the same during fast and slow declines in wealth. Fear does not manifest itself in the same way as when something is rapidly accelerating.
Fast declines raise the willingness to panic. Think about if you panicked during the lows of COVID crash. You would have lost close to thirty percent if you owned the sp500. And when you take a rapid hit to your wealth, it is hard to think clearly for a long time. It is easy to start worrying about more declines even as the market shoots straight higher on the back of government bailouts. You sold at a bad time and now are forced to chase everything higher. Double whammy.
To get the returns from the market, we don’t have to be in a position to panic sell. A properly placed tail hedge would have limited the need to sell at the worst possible time.