Drawdown – The Most Tragic Investment Failure

by | Risk

Drawdowns

Drawdowns – Tragic Investment Failure

A large investment drawdown is a tragic investment failure. A drawdown destroys investment capital and more often that not, shatters an investor’s confidence. Sometimes it even causes investors to lose their motivation to continue investing.

Losing your principal is the biggest risk in investing. Most investors don’t realize how devastating a large portfolio drawdown is to their long term returns. I will demonstrate the importance of avoiding these drawdowns.

Related Reading: Investment Risk Management Plan For Value Investors

What is a Drawdown?

The simplest definition is “the act, process, or result of depleting” (TheFreeDictionary)

A more comprehensive definition is “the peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted as the percentage between the peak and the trough.”  (Investopedia)

Investment Failure Caused By Large Drawdowns

A large drawdown can destroy your future. It robs you of the investment capital once had to grow your portfolio. Keeping drawdowns as small as possible is more important than high returns. This is why:

Drawdown:

Gain Required to Break Even:

5%

5%

10%

11%

15%

18%

20%

25%

25%

33%

30%

43%

35%

54%

40%

67%

45%

82%

50%

100%

75%

300%

90%

900%

Examine the above chart. Notice how the required gain to break even grows exponentially the greater the drawdown. This is because you are losing the investment capital that could be making you money when your investments are rising.

A 10% drawdown only requires an 11% gain to break even. A 30% drawdown requires a 43% gain. A 75% drawdown requires a 300% gain!

Five years of 15% annual gains followed by a 50% loss leaves you back where you started 6 years earlier. Nine years of 10% annual gains followed by a 57% loss (2007-09 bear market) puts you at break even for the entire decade.

Be Fearful When Others Are Greedy

In general, investors are too greedy when prices are high. Our emotions cause us to want to be part of the crowd. We compare our returns to the indices. We listen to our friends and colleagues who only boast when they are doing well.

When valuations are high, the probability of success is low, yet we become careless and fixate on past returns. Instead we should be concerned about preserving capital for the time when valuations are low and probabilities for success are heavily in our favor.

Do you want to avoid a large portfolio drawdown? The AAAMP Value Blog has a great deal of valuable information to help you successfully manage your portfolio. Start here:

10 Investing Principles Fundamental to Successful Outcomes

Market Timing vs. Valuation Timing

Probable Maximum Loss – How to Control Investment Portfolio Losses

Value Investing Portfolio Management Guides

AAAMP Value Newsletter - Global Deep Value Asset Allocation Portfolio

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Arbor ETF Portfolios Newsletter:  ETF Conservative Portfolio, ETF Dividend & Income, &  ETF Aggressive Portfolio

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Disclaimer
While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice. Consult your financial advisor before making investment decisions.

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