By LouAnn Schulfer, AWMA®, AIF®
Accredited Wealth Management AdvisorSM
Accredited Investment Fiduciary®
When it comes to numbers, our minds tend to think in a linear fashion. Combine a minus ten with a plus ten and you have zero. Investment returns are different though. If you have $100,000 for example, and lose 10%, you are left with $90,000. From that point, a 10% gain is $9,000, resulting in an ending value of $99,000. That is what we call the effects of drawdown. The deeper the loss, the steeper the return needed to get you back. If you lose 10%, you need 11% to break even. If you are down 25%, you’ll need a 33% return to become whole again. Lose 50% and it’ll take a 100% return to make your money back: $100,000 x -50% = $50,000. That $50,000 needs to double, which is a 100% rate of return, to get you back to $100,000.
It is tempting to think professionals can exact-time the market to miss the losses and participate in the gains. The problem is, we’ve seen markets react faster to the upside than the downside at times, so the danger in a market timing strategy is knowing exactly when to get back in. Active managers may look to time longer term trends, which can prove advantageous. Rather than in-and-out in day-trading style, they may favor certain asset classes in given time frames. Diversification still helps to smooth out performance over time for the potential of a more comfortable investment experience. It is important to remember that stocks, bonds and mutual funds are not the only options for your money. Depending on the investor, smaller accounts may be able to tolerate more volatility and drawdown won’t be as painful of an experience as it may be in a larger account. After all, losing 25% on a seven figure account amounts to significantly more dollars than a four figure account. Finally, remember the fundamental rule of investing: allocate your accounts according to time frame. Short term, mid term and long term, with the least amount of risk in your shortest term investments.
Understand your risks and manage your money accordingly, remembering the effects of drawdown.
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non- diversified portfolio. Diversification does not protect against market risk.