The most problematic risk for an individual investor: drawdown
Words like “conservative”, “moderate”, or “aggressive” may not mean much to an investor when evaluating risk tolerance. Instead, the most important risk to individual investors is the loss of capital, measured by peak-to-trough drawdown. Managing drawdown within predefined limits that everyone understands keeps investors on track toward their financial goals.
Unlike institutions, individuals invest on a limited time horizon
Traditional buy-and-hold asset allocation strategies, such as the common 60% stocks and 40% bonds portfolio, were originally built for large institutions that have “infinite” time horizons like pension plans and endowments. However, individual investors don’t have infinite time horizons. In fact, dramatic or large drawdowns in investments can have far-reaching consequences. While institutions can continue to hold their positions during market downturns and may be able to contribute more capital, individual investors – especially retirees – may be reliant on withdrawals of capital to support their lifestyle. For many individuals, a loss outside their risk tolerance may mean an impactful change to their financial plan.
We guarantee investors cannot travel back in time
Performance is an uncontrollable variable. Yet the industry always focuses on backward-looking historical performance and track records. Unfortunately, investors can never have the performance that already occurred. Thus, when their actual performance differs from their expectations based on past returns, they often make emotion-driven decisions such as chasing returns at market highs or selling in fear near market bottoms. Instead of focusing on the past, we manage based on drawdown risk – why?