If the market drops 20%, what percentage does it have to gain to get back to even?
Our philosophy on managing money and wealth is really very simple, it is to protect against the downside and let the upside gains run. Our philosophy is based on helping you reduce risk and volatility and in focusing on the long term growth opportunities which may be available.
Consider this hypothetical example: if the market drops 20%, what % does it have to gain to get back to even? Let us look at an example. Suppose we start with $100,000 and the market drops 20%. Now we are down to $80,000 ($100,000-$20,000), if the market goes up 20% we go back to only $96,000 ($80,000x20% = $16,000). In fact, the market has to go up 25% just to get back to even.
Risk and volatility management is essential in helping to have success over the long term. Without a proper allocation it is easy to have a lower return for an acceptable amount of risk or, and we see this often, a client could easily be taking a higher amount of risk for the potential return of the portfolio.
Diversification is a widely accepted method of reducing risk. Most people would feel safer owning 50 stocks instead of only 1 stock. If we diversify across asset classes we could have a lower level of risk as well. Even within asset classes we want to diversify.
If we truly want diversification, we have to check for overlap within an allocation. This is a labor intensive project which requires a high level of technical expertise and patience. It is a multi-step process which is disciplined, focused and detailed. Our objective would be to hopefully create a more diversified, less volatile, less risky portfolio which should provide a higher return for the level of risk a client is willing to entertain.
Many investors do exactly the opposite of what they should do when they time their investments. Instead of buying low and selling high, they do the opposite. When enthusiasm for the market is high and the press is reporting glowing reports about gains in the market they feel the time is right to jump in. When the market turns and the press is bearish, reporting about drops in the market and gloom and doom in the streets, the average investor gets out. As a result, they buy high and sell low, just the opposite of what they want and what they should do.
We have a focused, disciplined approach to helping our client. On a periodic basis, we will look at the portfolio and rebalance it back to the original allocation. This forces us to harvest the gains (sell high) and reallocate these dollars to the other areas of the portfolio (buy low). This takes the emotion out of the process for the investor and helps them to follow the approach the professionals take in growing assets.
*Remember, the use of diversification and asset allocation do not guarantee against loss in a declining market.