It is constantly proclaimed in the media that we are experiencing the worst economy since the Great Depression. I agree the economy is bad and the investment markets have been terrible. However, to compare this downturn with the Great Depression is like comparing the Vietnam War with World War II. Both were horrible wars, but when you look at the actual statistics, there is no comparison between the two.
In our booklet, Seven Steps for Building Wealth, the fifth step is “Avoid Large Losses.” This month we will discuss what that means for investors as they invest during this difficult time.
From January 1998 through May 2009, our primary portfolio, “Top Flight,” generated a total return of 276 percent, versus only 15 percent for the S&P 500. Investors often assume that since our returns are high, our portfolios must take more risk than normal. Actually, the opposite is true. Much of our excess return has been generated by avoiding large losses.
We often get asked how we are doing in this current “depression” environment. Even though our long-term track record is exceptional, have our active allocation and risk management strategies paid off recently? Or would an investor be better off investing using the traditional approach of diversify first, then buy, hold, hope and pray? According to most advisers, this is simply the way markets are, and there is nothing else that can be done to reduce risk or improve returns.
In the most recent market cycle from Jan. 1, 2007 to May 31, 2009, the S&P 500 lost 31.6 percent of its value. Most investors have done even worse because of their allocation and the cost associated with their investments. During that same period of time, our actively managed Top Flight portfolio is down only 14.9 percent.
We are never happy to have negative returns. Our objective is to minimize losses wherever possible. This bear market has been more difficult for us than any of the previous ones. Almost all asset classes declined together. In the 1987, 1998 and 2000-2002 bear markets, we performed much better.
To truly compare performance, the most important question to ask is, “How much of a return is needed by each investment strategy in order to make back your money and get back to even?”
Calculating percentage returns is different than most investors realize. For example, if you have a 25 percent loss then you need 33 percent to get back to even — which is workable. If you lose 50 percent of your portfolio, you have to make 100 percent to get back to even — obviously a much more difficult task. A loss of 90 percent of your portfolio requires a gain of 900 percent to get back to even — forget about it.
I’ll compare our flagship portfolio, Top Flight, to the S&P 500. Most investors working with a traditional adviser will have a portfolio whose returns at best are similar to the S&P 500.
For Top Flight to get back to even and recover its 14.9 percent loss, it only needs to earn 17.5 percent. For the S&P 500 to recover its 31.6 percent loss, it will need to earn 46.5 percent to get back to even. As you can see, the size of the loss has an exponential negative effect on an investor’s ability to recover. It will take investors in the broad market (S&P 500) almost three times more effort just to get back to even.
Step number five, Avoid Large Losses, seems pretty straightforward and simple. Actually avoiding losses is much more difficult when investing real money, which is why it is imperative for investors to follow a disciplined, non-emotional, proven strategy if they hope to succeed over the long term. UV
The views in this column are the opinions of Dave Young. They are not intended as a forecast or a guarantee of future results.