Critical Investment Strategies For Downside Protection
Successful investment strategies are less about capturing 100% of the market’s upside and more about missing the potholes.
Avoid the Most Significant Investing Mistakes
The extreme volatility from the 2008 – 2009 financial crisis provided one of the most severe environments to illustrate this concept; while most investors have recovered their losses, the wild ride they took has left a lasting impression. More recently, the volatility that we have seen in 2018 has reminded us that we don’t like to see significant fluctuations in our portfolios.
Although you will never be able to eliminate the volatility associated with the journey, you can certainly make the journey more enjoyable with some preparation and smart investment strategies before you start.
How Will You Get There?
The first step is to gain an understanding of your propensity to accept volatility, or your risk tolerance. It is common to feel more comfortable with risk when discussing it or thinking about it conceptually versus when you are experiencing it first-hand.
As a point of reference, many people who in 2007 indicated that they would be able to handle a significant decrease in portfolio values because they had time to recover, had very different feelings in 2008 when they experienced substantial declines. Putting dollar figures to percentage declines will aid you in having more real-life conversations about volatility – talking about a 10% decline on a one-million-dollar portfolio is very different from talking about losing $100,000.
This concept deals with absolute returns versus relative returns or said another way, how much risk was assumed to generate the return during any given period. As you compare different portfolio structures or investment strategies, it becomes very apparent that not all 10% returns are created equal. If Portfolio A took twice as much risk as Portfolio B for the same 10% return, you can see how Portfolio A significantly underperformed Portfolio B; with two times as much risk, you should expect a 20% return. The result is that Portfolio A substantially underperforms on a risk-adjusted basis.
Focus on What You Need
The best way to avoid taking more risk than is prudent is to focus on what you need, not what you can get. By structuring your portfolio to earn the returns that you need to meet your goals and not the highest absolute returns that you can get, you will increase your ability to keep volatility in check.
There is no substitute for detailed retirement planning and projections when you quantify your needs. The myriad of rules-of-thumb and basic online calculators will be fine for most people in their 20’s or 30’s, but as your income and portfolio grow there are nuances and variables specific to your circumstances that need to be considered.
When Is It Time to Change Course?
Rest assured that the course you start on today will need to be changed, or at least be adapted, over time. Your comfort level with risk will change over time. Your need to accept risk will change over time, and the risk environment will change over time. Each of these variables needs to be considered as you reevaluate the level of risk in your portfolio. This macro decision needs to be revisited at least once a year.
Assess Your Situation
No single approach will be appropriate for everyone’s investment strategies. Do your analysis to determine what makes sense for you and keep in mind that your plan will need to adapt. Quantify the risk you are currently accepting and make decisions accordingly.
One of the most fundamental and significant investing mistakes that you can make is taking risk that you don’t need to take.