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Fear of missing higher returns may cause investors to increase risk. However, limiting downside can be just as important as upside participation.

Large Losses Main Image

Given the strong returns of domestic equities over the past 10 years, investors may be considering shifts to a more aggressive risk profile and reducing exposure to other segments of the market. However, while maximizing upside is the goal for every investor, lessening drawdowns can be just as impactful to long-term performance.

The chart above illustrates the math of volatility, showing that the greater the loss experienced, the larger the gain that is needed to bring the portfolio back to its original value. In order to just break even, a 5% loss requires a 5.3% gain, a 25% loss requires a 33.3% gain, and a 50% loss requires a 100% gain. There’s no question that U.S. large cap stocks have dominated in this recent bull market, but they have also experienced meaningful sell-offs over the last 20 years. Shifts in market dominance are inevitable, as top performers take their turn near the bottom of the pack, and key to why diversification works.

Maintaining a diversified approach can help to mitigate the downside in market sell-offs and provide a smoother ride for investors to achieve their goals. Less volatility also helps investors to stay in the game and not abandon one’s strategy at the worst possible time. Ultimately, we caution against dismissing the benefits of diversification today.

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all of the information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.