And Bitcoin’s volatility should burn investors!

Just over 10 years old, Bitcoin might already be the best-performing investment of all time. It might also be the most volatile, and volatility has a way of luring people into ill-timed and costly investing choices. So with all the headlines about Bitcoin’s meteoric rise, it seems reasonable to ask how its investors are doing.
There’s no denying Bitcoin’s astonishing success. Its price has grown a stupefying 796,933 times since 2010. For perspective, the Dow Jones Industrial Average has grown 869 times since its inception in 1896. That means Bitcoin’s price appreciation has been 917 times that of the Dow in less than a tenth of the time. With a surge like that, it doesn’t take a big investment to make a pile of money. A measly $100 bet on Bitcoin on Day One, or close to it, would have blossomed into close to $80 million. And investors didn’t have to be there from the beginning to rack up big gains. They just had to hop on somewhere along the line and hang on to their coins.
The trouble is, Bitcoin’s wild swings don’t make it easy to hold on. Its volatility, as measured by annualised standard deviation, has clocked more than 200% since 2010, or close to 15 times that of the S&P 500 Index during the same period. Investors who were in and out of Bitcoin had as much opportunity to lose a fortune as make one.
Investments with far less volatility than Bitcoin have been known to trip up investors. Faced with big and unpredictable price moves, those who have trouble staying in their seat are more likely to buy on the way up and sell on the way down rather than the other way around. Morningstar’s annual “Mind the Gap” report attempts to quantify the impact of investors’ behavior on their investment returns by measuring the so-called behaviour gap, or the difference between the performance reported by investment funds and the returns investors in those funds manage to capture. The results strongly suggest that more volatility leads to bigger gaps, and not in investors’ favour.
While gaps can be caused by numerous factors, volatility seems to be a key one. According to the latest report, investors have fared best in allocation funds, or those that combine stocks, bonds and other investments. The gap in those funds was 0.4% a year over 10 years through 2019, meaning that on average investors captured a higher return than the one reported by their funds. One reason, as Morningstar puts it, is that “by virtue of their diversified approach, allocation funds tend to have more-stable performance and are easier to own than funds that are subject to more-dramatic performance swings.” By contrast, investors in sector-specific stock funds, which tend to be more erratic, gave back 1.35% a year, the widest gap in either direction.
If volatility is inversely related to the behaviour gap, then Bitcoin’s gap should be alarmingly negative. It’s difficult to track the money flowing in and out of Bitcoin, which is part of the charm, so it’s hard to be sure. But the available numbers suggest just the opposite — investors appear to have deftly navigated its harrowing highs and lows, buying on the way down and selling on the way up.
Bitcoin has already been through two spectacular boom-bust cycles. It surged to a high of $1,137 from just $0.08 from July 2010 to November 2013, and then tumbled 84% to $183 by January 2015.

—Bloomberg