Which Assets Have The Highest Volatility Tax?

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Long-Term Capital Management grew at 30% per year from 1994 to 1997 and then dropped 92% in 1998. Investors were effectively wiped out, yet the fund’s historical average annual return is a placid sounding +5.8%.

Investors earn compound returns, not average returns. Compound returns measure the total effect of a long-term return series and are a more accurate metric of investment growth. The difference between compound and average returns is called the “volatility tax”. This post shows the historical volatility tax for major asset classes.

“The volatility tax is the hidden tax on an investment portfolio caused by the negative compounding of large investment losses.” Mark Spitznagel

The table below shows annual returns for major asset classes.

Sources and Disclosures

Most investments take the stairs up and the elevator down. Particularly bad years increase the volatility tax over time, making it difficult for an asset to get back to its all-time high. For example, US stocks fell 37.0% in 2008. $100 became $63. US stock investors needed to earn 58.7% to get back to even, substantially more than the 37.0% loss.

The chart below plots both average and compound returns for each asset.

Sources and Disclosures

Emerging market stocks had an average annual return of 10.6% from 1992 to 2018, at first glance outpacing the 10.5% average return of US stocks. Yet the compound return of emerging market stocks was only 4.6%, meaning they actually underperformed less risky assets like government bonds.

Sources and Disclosures

Another way to visualize the volatility tax is to scale it by an asset’s average annual return. For example, the annual volatility tax in commodities of 3.6% wiped out 99% of the average return of 3.7%. In other words, $100 invested in a broad commodity index in 1992 was still $100 in 2018 (likely less after fees).

Sources and Disclosures

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Disclaimer: MVMT Capital LLC (“Movement”) is a registered investment adviser located in Jackson, MS and is registered in the state of Mississippi. Movement may only transact business ...

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