High quality debt assets do not generate returns over short periods as high as equities do, but they do not experience Maximum Drawdowns as severe as stocks – thus moderating overall portfolio Maximum Drawdown. Same thing with portfolio risk diversification (diversified asset return correlation), which is predominantly accomplished with high quality debt assets (particularly Treasuries). Then you are so glad you had the insurance. You lament the premium you pay for your auto, home or medical insurance, until you have a major claim event. It has a cost, at least it seems that way almost all the time, except in the instance that you need it. Unfortunately, diversification is a bit like insurance. And, those are the reasons as we achieve more and more of our ultimate accumulation (Financial Capital), and the present value of our future earnings from work (Human Capital) declines, and the number of years we have before beginning to withdraw assets decreases (Time Horizon), that we need to diversify our risk (specifically the correlation of return of the assets we own), to mitigate the damage that a stocks Bear market can have on the ability of our portfolio to support our lifestyle now or in the future (to avoid the Risk of Ruin – outliving our assets – to protect Portfolio Longevity). Those are the reasons that generic advice to someone starting out is to put all assets in stocks, to maximize regular monthly savings, and damn the torpedoes in a Bear market.
Maximum drawdown full#
Of course, if that person has such a large asset base that withdrawals are less than the investment income (interest and dividends), for that person the Bear is more an annoyance than a threat and may present some attractive asset substitution opportunities.īut for most of you, and for me, the Bear is more of a threat than an opportunity if we lean into it and take it in the face full force. However, for someone, regardless of age, who has completed the process of adding new money to the portfolio, and is relying on the portfolio for sustenance, the Bear presents a threat not an opportunity. Many of us, don’t have the luxury of waiting 4 to 6 years to breakeven with pre-crash levels, particularly if we are making regular withdrawals from our portfolios to support lifestyle.Ī young person with only a small portion of future accumulations achieved, engaging in regular periodic investments, can not only ignore most Bear markets, but actually enjoy buying more shares each month at a lower price during a Bear – maybe even increasing the rate of investment during a Bear.
This table shows how long it would take for total return breakeven after various levels of portfolio decline, assuming various post-drawdown rates of return: Of course, a portfolio diversified with debt assets, experienced a less extensive drawdown and a total return recovery over a shorter period. Total return recovery from the 2000 Bear took 6.15 years, and from the 2007 Bear it took 4.5 years. Since 1936, US large-cap Bear markets have taken mostly 4 to 6 years from the pre-crash peak to the bottom and back to a breakeven level. We prefer to take cover in falling markets, by tilting away from equities toward bonds or cash. We are in the Tactical Trend Following camp for long-term trend reversals. In the battle of philosophies between Buy & Hold and Tactical Trend Following, the long recovery time after a Maximum Drawdown is the trend follower’s main argument. Maximum Drawdowns occur infrequently but massively, and it typically takes years to breakeven with the pre-crash portfolio value. In this letter, we examine Maximum Drawdown Risk, which is probably the greatest risk portfolios face over the next couple of years. Here are 10 of them:Įach of these deserves attention in portfolio construction. There are many types of risk when investing.
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