Investment & Finance

Wealth Building: Minimize Losses in Downturns

January 17, 2024
5 minute read
November 16, 2023
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When it comes to strategies, most investors are focused on chasing the market’s best days. After all, it seems logical, especially when the market has been ripping for the past 20 years. However, what’s counterintuitive is that avoiding the market’s worst days yields better results than trying to chase its best ones. In other words, the key to building long-term wealth is by minimizing losses, not maximizing gains. Don’t spend your time as an investor chasing the hype, drive on the avenue of profitability. 

The best days are in the worst times. 

Although intuition takes over for both casual and career investors, the numbers are often contradictory to perception. Investors get hyper-focused on the best days during a bull market, but the actual best-performing days (shocking for all who don’t know) statistically occur in a bear market (according to JP Morgan). 

The US stock market has been on an upward trajectory for over 20 years; when it dips, it has to go up. So if it dips significantly, then it goes back up in huge numbers, giving investors their best recorded days. It seems backward, but it’s true. 

The following graph depicts the market’s 10 best days and the % of their return.

If you look at the dates, you’ll notice several are from difficult economic periods (2008, 2020), which is why when investors panic sell all their assets after a dip, it’s a bad decision. The market will go back up. This means that the investors who panic sell their assets won’t experience the best days, thus hurting themselves in the long run because of the emotions behind the investment.

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Avoiding the worst days beats chasing the best.

Instead of panic selling, should investors use the “buy-and-hold” strategy? Although it’s the complete opposite, it still isn’t looking at the whole picture. A majority of the best days happen in a bear market, so it makes it essential to try and hit all the best days! Staying invested during the most profitable days will obviously have a greater return, and since the best days happen during the worst times, timing is essential. When investors pull out of panic, they miss the best days, further hurting their portfolio, while the buy-and-hold method proves to be effective in bear markets because investors stay in the market. The following graphs demonstrate the significance of staying invested throughout volatile times.

According to this JP Morgan report, staying invested in the downturn, the buy-and-hold method is the better way to get a greater return. In fact, missing just 10 of the best days decreases the potential growth by over 50%. Why doesn’t everyone keep their money in the market all the time? Because the landscape of the financial market is more complex than just hitting the best days. Instead of only hitting the best days, reframe investing for profitability because the significant picture yields long-term wealth.

Instead of hyper-focusing on hitting the best days, how can an investor find room for profitability in a strategy? The alternative is to start exploring opportunities in the worst days. The opposite is true of the buy-and-hold method regarding the worst days, with the following graph visualizing how missing just 10 of the worst days shapes a portfolio. 

What becomes dauntingly evident is that by missing the worst days, you’ll achieve greater profitability than by chasing the best days! That is entirely counterintuitive to the “buy-and-hold” strategy concluded from the first graph. Staying invested in all the best days means a growth of up to $68,844, but avoiding all the worst days could yield up to $504,491 (and more). The goal should always be to emphasize profitability, not gains, which is a balancing act of risk management. 

There's a reason why great investors don't use “buy-and-hold” strategies.

Looking back on prevalent investors and economists, not one of them endorses the strategy of buy-and-hold. In fact, the market provides such a multitude of nuances and complexities that the buy-and-hold strategy ignores a fault. Although it does reinforce staying invested during the best days, it misses the opportunity surrounding loss minimization. 

Why shouldn’t investors focus only on the best days? The best days will give you a return rate, but you only get a return on what you don’t lose. Let’s say you invested $1,000 and the market declined by 10%. You would lose $100 and have $900 left. Now let’s say the market regains 10%. Your $900 would turn into $990, not $1,000. To break even, you would have to make back 11.11%, not 10%. So every dollar lost leads to a bigger hole that you have to dig yourself out of before you can see a positive return. In this fashion, avoiding losses is actually better than chasing gains.

Another reason buy-and-hold isn’t encouraged is that 7 out of the 10 best market days occur in bear markets/economic downturns, so focusing on missing the downswings and getting in on the upswing will yield greater returns, which occur during those bear markets. 

To capitalize on both the best and worst days, investors need to learn the balancing act of active risk management and not just simply trying to chase all the best days. 

How do you make it all happen? 

Essentially, you must time it right; how do you consistently make that happen? alphaAI! Our AI technology automates essential portfolio management functions like risk management and downside protection to help protect your investments during downturns and times of high volatility.

The predictive capabilities of alphaAI, based on billions of data points, will automatically adjust to the market and help you achieve lower drawdowns than similar passive investment approaches. 

At alphaAI, we don’t promise to beat the market or oversized returns, but rather, we focus on providing a systemic and rules-based investment approach. By staying consistent, avoiding emotion, and focusing on active risk management, we are able to generate reproducible, risk-adjusted returns that help our clients achieve their financial goals year after year. 

Learn more about our technology and how we’ve been able to outperform buy-and-hold strategies on our website.

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