Understanding the Law of Losses

Successful investing depends upon an investor’s ability to withstand losses and the time needed to get back to breakeven. A major tenet of risk management is the importance of avoiding catastrophic losses. The lower the drawdown, the less time it takes to recover, allowing for the power of compounding to resume and to provide peace of mind.

WHAT CAN ONE LARGE DECLINE DO TO YOUR PORTFOLIO?

Law of Losses

MAX LOSS DURING HIGH RISK EVENTS

Research by Nassim Nicholas Taleb, the New York Times best-selling author, describes a Black Swan as a highly improbable event with three principle characteristics: it is unpredictable; it carries a massive impact; and after the fact, we concoct an explanation that makes it appear less random and more predictable than it was. Passive asset allocation has proven to fail during high risk events because all asset classes usually decline at the same time. What may be better suited for the demands of today’s investors is to utilize multiple strategies with multiple managers that can take defensive action, thus lowering overall portfolio drawdowns.

max loss during high risk events
rule of 72

The Power Of Compounding

Considered by Einstein to be the 8th wonder of the world, the magic of compounding is when gains that accrue on an investment are added to the previous gains. He referred to it as The Rule of 72; when you divide 72 by the rate of return, it will tell you how many years it takes for your money to double. In the example below, a 12% return doubles your money about every 6 years.Passive asset allocation has proven to fail during high risk events because all asset classes usually decline at the same time. What may be better suited for the demands of today’s investors is to utilize multiple strategies with multiple managers that can take defensive action, thus lowering overall portfolio drawdowns.

However, if during your lifetime you experience three separate -50% drawdown events, it greatly diminishes your performance over a lifetime due to the time it takes to recover. This dramatically reduces compounding.

YOUR PORTFOLIO IS REDUCED BY MORE THAN 90%

power of compounding