When it comes to investing a loss has more of an impact than a gain. Once a loss occurs, not only do you lose an actual dollar amount and then have to gain it back, but the momentum of compound interest stops, and you lose what those dollars could have earned over time; potentially costing you hundreds of thousands of dollars.
Actual Historical Performance:
To illustrate, let’s look at the most recent 15 years of past market performance. We will start off with two investments, each having $100,000. The red line will represent one having market participation in the s&p 500 with no limits. The blue line will represent an alternative investment, having participation but without any losses, and to prove that a loss has more of an effect, we will limit the growth with a ceiling of 8%. So the most you could earn in any given year is 8% and the most you could lose is 0%.
As you can see with the red line, a loss in any given year proves to be destructive, not only because of how much the loss actually costs numerically, but how long it can take to recover; and when you are trying to build wealth, time is critical.
What do you constantly hear from the media and wall street?
“Buy and hold. You will have ups with the market and you will have downs, but over time you will average a good rate of return”.
Looking at the line graph above, is a “buy and hold” strategy the best way to grow your money? So why is that the way most people believe they should invest?
By avoiding losing your principal and interest (i.e.the blue line) during a market downturn, you have allowed yourself to spend less time making up previous losses. This enables you to not be chasing high returns (which increases your risk) in order to compensate. By being more efficient you can achieve an increasing pool of capital with only a modest rate of return.
Your main concern should not be chasing high returns and benchmark indices, but the preservation of your capital.
As Lance Roberts of Real Investment Advice states:
“Our job as investors is to navigate the financial markets in a manner that significantly reduces the destruction of capital over time. By spending less time making up previous losses, our investments advance more quickly towards our long-term objectives.”
Is there a pattern here?
In my other article “Which Rate of Return Have You Been Shown?” you will have read how the marketing machine has you focusing on the simple “average” rate of return and not the “actual” rate of return or geometric mean. They do this because it makes their numbers look better. However, the “actual” rate of return is what really matters.
If we compare the simple average return versus the actual return of this example; the red line (s&p 500)had an average rate of return of 6% and an actual rate of return of 4.39%. For the blue line the simple average is 5.09% and the actual is 5.03%. Because there is less dispersion from the mean in the latter data set compared to the former, the two types of returns are actually closer. This also indicates that there is less risk associated with that data set. So even though the average return was less, the actual return was higher. Which would you rather have?
The problem American people face is they are brainwashed into believing that chasing high returns is what they’re supposed to do and how success is born for financial planning. It’s not.
Over the years, constant down swings will cost you hundreds of thousands of dollars. They are an anchor weighing you down. Could you still have a decent amount of money when you retire with the buy and hold strategy? Sure. Could you have had more if you avoided those losses while only having a modest growth rate? Yes.
How will the next market loss affect your wealth?
Here are our top five alternative investment recommendations which have predictable results, are backed by real assets, and take out the emotional biases which cause most investors/advisers to continually fail.
Contact us for help. Or download our ebook, Financial Planning has Failed to learn more about your options.