Humans care more about losses than we do about gains; we also have many investment biases studied by behavioural scientists which I find fascinating. I will always remember with amusement a client who told me her investment return dream scenario, “100% upside and 0% downside, in 5 years, “she said. We both laughed, of course.
Pre 2008, I don’t remember having to discuss drawdown (decline in investment or fund) risks with clients; it became necessary to illustrate after the ’08 crash – bonds are held in portfolios as insurance, to help manage this risk.
Yes, we all love the higher returns from equities, and yet, you also have to consider the downside losses too, when evaluating the appropriate risk for your portfolio.
Compounding works in both directions. The bigger the loss, the harder it is to make a recovery. A 10% loss requires only an 11% subsequent gain to get back, while a 25% loss requires a 33% recovery and a 50% loss requires you to double your money to get back to your original position. The picture above illustrates this well.