Losses in a market decline today

"Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1."

Warren Buffett

The most common advice I hear everywhere is, "Just stay invested high or low just leave your money in the market because in the long term, you'll come out ahead." Although that may be technically correct, what you sacrifice is monumental opportunity costs, which are the biggest loss of all. In this article.

As the market declines today

I'll break down how I think about market drawdowns and how to manage the risk so you can profit from the opportunity.

Being invested in a market with no risk management strategy can be painful but most people don't appreciate the total magnitude of the opportunity that is being missed.

This unfolds in two parts, first the recovery costs, it requires exponentially more growth to recover from an investment loss, the bigger the loss the longer the recovery.

And if that's not bad enough the biggest loss is all the progress/profit you've made leading up to the downturn. Typically it takes much longer for growth in the market, so if we look at the financial market collapse of 2009 and let's imagine I followed the typical advice of 'just stay invested' throughout. I would have evaporated 6 years' worth of market growth. That is time that I can never recover. Even if the market returns to the previous high I have lost 6 years worth of growth opportunity.

So just staying invested in the market blindly is madness in my opinion, we have to manage the risks to protect our capital and capitalise on the opportunity drawdowns present.

Ways not to be a loser

As the market declines today there are a few different ways to mitigate investments from loss, each has a cost and benefit associated with it.

Diversification

This is probably the most common one people refer to where you purchase investments that are uncorrelated with the market to counteract the impact of a loss. Check out our new Diversification Engine calculator that assists in reviewing how well diversified your portfolio is relative to the market.

Cost

By investing in other investments that move in the opposite direction there is a drag on your primary investment that slows the growth that would otherwise be achieved. And I consider this lost opportunity the cost payable.

Benefit

Less volatility (up and down extremes) within the portfolio. And provided all investments are moving in an upward direction long term the overall portfolio will grow too with less extreme swings.

Lower overall portfolio volatility

Insurance

Options allow for insurance against loss, this is mostly utilized by advanced investors the details of which are beyond the scope of this article.

Cost

Options decay over time eventually losing all value, that value decay is the cost of insuring against the loss of capital.

Benefit

They are relatively cheap to purchase (depending on the market risk at the time). A large position can be protected for much less capital outlay than what's required for a diversified position.

Weightage

The most effective way to avoid losing capital during a market drawdown is to withdraw your funds before the market declines. However, the challenge lies in knowing when to do this. Since no one has a crystal ball, market timing is often frowned upon by the majority. If done incorrectly, you risk missing out on long-term market gains, as you may have to buy back in when the market has already moved higher.

Benefit

No upfront cost, retain all your capital, and during growth periods growth isn't constrained by other costs like options or diversified investments moving opposite (i.e. making a loss).

Cost

If timed incorrectly lost opportunity can be significant.

In Summary

Think about risk management and prepare prior to market declines so that you don't have to suffer the loss of capital and time.

Upcoming events

After many years of trial and error, I have developed key strategies to manage this risk effectively. My approach aims to maximize investment potential while minimizing the risk of loss. For the first time, I am offering limited spots to the public to share what I have learned and show you how you can also leverage downturns for profit.

Check out our next Free event here!

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