The first rule of investment management should be “Don’t lose money.” Clients entrust us with their life savings, their pot of gold, so that it can be a bigger pot sometime in the future, when they need to draw upon it for retirement income.
Generally, people like to talk about how much money they made investing. You know those people at cocktail parties who go on and on about how much money they or their broker made them last week. Or how they found the next big thing, the next Microsoft or Google and how they’re going to retire rich. Of course, many of these stocks lost significant value in 2022 so maybe they’re not bragging too much these days.
Even the magazines that target the do-it-yourself investors seem to talk about what did well last year. There’s always a list of the top funds from last quarter, last year, the last three years. Some of this is by necessity and common sense. The securities rules say we cannot claim to predict the future. Also we have to state past performance is no guarantee of future performance. Typically what gets lost is that first rule we mentioned earlier, don’t lose money. Or at least lose less than the market.
It’s important for a number of reasons. Research has shown that investors are more upset at losing money than they are happy at making money. Just like in athletics, the pain of losing is usually stronger than the euphoria of winning.
But it’s also just plain arithmetic. People forget that you have to make more than you lost to overcome that loss. A twenty percent loss means you need a twenty-five percent gain just to get even. If you start with $100 and lose twenty percent, you have $80. To get back to $100, you need a twenty-five percent gain ($20/$80 = 25%). A thirty percent loss needs a forty-two percent gain. A fifty percent loss needs a one hundred percent gain. You get the picture; it takes a long time to overcome massive losses and get back to even.
While professional investment advisors cannot guarantee against losses, we can help minimize them. One way is to determine each investors risk tolerance and design a portfolio accordingly. Sounds boring, but it is effective. In 2022 an aggressive investor with one hundred per cent exposure to the Nasdaq 100 Index would have lost 32.4% and needed a 47.9% gain to get back to even. However, a more conservative investor with a sixty percent allocation to the S&P 500 and a forty percent allocation to bonds would have lost 16.1% and needed a 19.1% gain to get back to even. We’re not trying to make aggressive investors more conservative. What we do want to is make sure aggressive investors really are aggressive, not more conservative investors who are misinformed.