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A Winning Portfolio: Avoiding Big Losses May Be More Important Than Max Gains

October 19, 2017 | Craig Birk, CFP®

“Winning isn’t everything — but wanting to win is.” ― Vince Lombardi

Winning—it’s part of our DNA. We celebrate winning teams, winning people, and winning businesses. But while an unrelenting focus on winning has created lots of celebratory moments for humans everywhere, it can potentially give you a severe headache if you let your drive to win control how you manage your investment portfolio.

In long-running bull-market environments, like the one we are currently experiencing, some investors begin focusing on maximizing their returns. They start to measure their success against every investment story they hear. For example, cocktail-party talk about an investment windfall can trigger dissatisfaction for some investors who begin to believe that merely making a solid, steady investment return is not enough reward.

While there is certainly nothing wrong with taking a serious interest in your investments and keeping current on new ideas and strategies, you may be going too far if you become so focused on chasing returns that you make investment-strategy changes based solely on your desire to “win.”
In addition to the unnecessary stress this causes, you can damage the value of your investment portfolio. A well-diversified investment strategy will never make you a “winner” if you only measure winning by short-term gains—or cocktail-party bragging rights. That’s because a diversified investment strategy is designed to provide both return and risk control, which are invariably absent in any story qualifying for bragging rights.

This return-chasing behavior allows emotions to control your investment strategy, which can be significantly harmful to your financial future. Why? Because simply avoiding big losses can be much more important to your long-term investment strategy than capturing maximum market gains during any short-term period.

For example:

    1. 1. If you start with a $100 and you suffer a 20% loss, what level of subsequent return brings you back to a breakeven point?
    1. 2. If you suffer a 60% loss, what subsequent return do you need just to break even?
    1. 3. If disaster strikes and you lose 80% of your $100 investment, how much return do you need to fully recover your $100?

The answer to question one is 25%. That’s right, you need a return of 25% to break even if you faced just a 20% loss. As the losses mount, the news goes from bad to horrible. If, as in question two, you suffered a 60% loss, you need a 150% return to simply recover. And if you lost 80% of your $100, you will need a 400% return just to recover.

The deeper the hole you dig, the harder it is to recover. Because of the extreme nature of loss recovery, some of the best investment decisions you can make may be acts of omission—simply avoid chasing the latest stock tip or the next new thing.

[Read more about investor FOMO and how it can hurt your long-term success]

Disciplined investment behavior could be the single greatest determinant of good investment outcomes. If you have worked with a financial advisor to carefully create your own diversified portfolio—one that accommodates both your long-term goals and your personal risk-tolerance level – stick with it.

Diversity likely won’t make you a star at a cocktail party where everyone is bragging about outsized market gains, but you likely won’t be risking your long-term financial goals, either.

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