Rule #1 – Avoid major losses.
Abide by rule number one, and everything is made easier. By everything, we mean the ability to generate sufficient returns and compound wealth.
This will be a short note…a reminder of the risk that grabs our attention, and the actions we are constantly taking to defend against it. During extreme political, economic, and overall uncertainty – we are hoping this brings a sigh of relief. More detail into this line of thinking is outlined in our Drawdown Patrol Investing paper; this will be a form of cliffs notes.
The Marriage of Risk and Return
This relationship won’t break. In fact, it can’t break. There’s no way to find investment returns without assuming risk. But as Benjamin Graham says, “The essence of investment management is the management of risks, not the management of returns.”
Risk can be defined in fancy ways, but the risk that worries us most at Aptus is drawdown risk. It is our opinion, all other forms of risk pale in comparison in importance and impact on the investor’s eventual outcome. Why? Because of behavior and math.
Behavior
An advisor can estimate an investor’s risk tolerance and risk capacity. The problem is those things change. If you had $1,000,000 in the S&P 500 on February 19–March 23, you would have been holding nearly 35% less. Think about that. In four weeks, a $350,000 loss. It would take nerves of steel for most of us to not have some level of concern.
From a behavioral standpoint, nothing can throw a well-laid plan off course like a large drawdown. As we say, the path from point A to point B matters. The smoother the better.
Math
Large losses crush your ability to compound capital mathematically.
One way to think about this is through length of recovery. The further down you go, it just takes too long to recover.
Another way of thinking about this is through the law of percentages. It simply states, losses hurt more than gains help. A simple example, to piggyback on this year’s actual numbers:
Assume you lose 35% and then gain 35%. Because you are losing 35 on a higher base and earning 35 on a lower base, you end up in the hole still down 12.25%.
- $1,000,000 * (1 – .35) = $650,000
- $650,000 * (1 + .35) = $877,500
- Starting Value of $1,000,000 – Ending Value of $877,500 = Loss of $122,500
Our Portfolios
Uncertainty abounds, and we could list the reasons for that, but what’s more relevant is what we are doing about it.
We are not trying to time the markets by holding cash. The markets have shown us, in short order, the magnitude of opportunity costs that cash can create.
What we have done is build more exposure to holdings that we think can benefit from volatility rising. Owning hedges was a huge help in the February-March drawdown, giving holders the opportunity to take advantage of volatility spiking and markets dropping. Our portfolios are now back to a more defensive position than we can recall them ever having.
We’re aware that risk and return are a packaged deal. We will experience losses at some point. Losses don’t scare us. Large losses do. We are positioned accordingly as we move into the latter part of the year.
If you’d like to see any type of stress test or scenario analysis on your portfolio, ask! Words are one thing, seeing the math of worst-case scenarios is different. Those numbers should bring a sign of relief.
As always, thank you for your trust and don’t hesitate to reach out with any questions at all.
Disclosures:
Past performance is not indicative of future results. Investing involves risk including the potential loss of principal. This material is not financial advice or an offer to sell any product. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Aptus Capital Advisors, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. Forward looking statements cannot be guaranteed. This is not a recommendation to buy or sell a particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment and tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.
Advisory services offered through Aptus Capital Advisors, LLC, a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and headquartered in Fairhope, Alabama. Registration does not imply a certain level of skill or training. More information about the advisor, and its investment strategies and objectives, is included in the firm’s Form ADV, which can be obtained, at no charge, by calling (251) 517‐7198. ACA-2008-1.
