Wall Street is a cyclical beast: It rises for a while and then falls; it moves steadily for a while and then starts behaving more wildly. And then those cycles repeat. So why, asks Motley Fool Money listener Dan, shouldn't investors buy a VIX tracking fund when volatility is low, sell when volatility spikes, and then repeat the cycle until they're rich?
In this segment of the Motley Fool Money podcast, host Chris Hill and Fool senior analysts Andy Cross and Ron Gross answer that question with a twofold warning.
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This video was recorded on Sept. 20, 2019.
Chris Hill: Question from Dan Rogers in the UK. Dan writes, "I was recently made aware of the VIX index, which aims to track the volatility of the S&P 500. For me, it would make sense to simply buy the VIX during times of low volatility and hold until the market becomes more volatile, which occurs fairly often, and then just repeat the cycle. Is there something I'm missing here? Or is this a sensible strategy?" What do you think, Ron?
Ron Gross: Oh, Dan, if it was only so easy, we'd all be doing it. You are correct, it's the investor fear gauge. A high VIX reflects increased investor fear. Low VIX suggests complacency. But you can't directly by the VIX. You have to do it through an ETF or an ETN, exchange traded note. It's basically, at the heart, a market-timing strategy. Your rate of return is going to be based on your ability to get in at the right time and get out at the right time. As long-term investments, these are not good. For example, one ETF is down 95% over the last five years. It's your ability to get in at the right time and get out at the right time. I would suggest that that's a hard game to play. There's also structural problems with the way these ETFs are structured, which takes away from the profits that you could actually earn. The performance digresses from the actual VIX, which makes it an even tougher strategy. I would stick to being a long-term, diversified investor.
Andy Cross: I think that's right. I've never invested in the VIX. I've never played with it. You certainly don't have to. We're not missing anything as long-term investors. It's not something that you have to rush into. Like Ron was saying, the structural differences are the real worry with trying to trade around into the VIX.
Gross: And while certainly there are some speculators, it's more often used by professional investors as a hedge to reduce risk in a portfolio. So, again, I would stay away. Just be an investor, not a speculator.
Hill: Also: taxes.
Gross: Yeah, short-term taxes, for sure.