#6 Drawdown: How much loss can you afford?
Today we are talking about a topic that is of great importance to many of you: risk. Especially in the context of equity investments, risks are omnipresent and deserve our attention.
Shares are considered one of the best asset classes over the long term. If we look at the past, for example at the U.S. stock market, we see that equities have generated an annual return of around 6 to 7 percent over the economic cycle, adjusted for inflation. At the same time, however, equities are also very volatile, meaning that their value fluctuates greatly.
The volatility of shares
It may sound surprising, but even if you diversify your portfolio well and invest in many different stocks, you can expect the value of your portfolio to drop by up to 50 percent at times. This has happened in the past. One example is the «Great Depression» in the U.S., when the American stock market plummeted by more than 50 percent. Another example is the financial crisis in 2009, when the stock market also fell by more than 50 percent.
A frequently asked question is, «Can market declines be predicted?» The simple answer is, unfortunately, no. Even experts who try are often wrong.
Strategies to protect against crashes
But how can you protect yourself from the next crash? One strategy is to diversify your portfolio across different asset classes and markets. While this mitigates the impact of a crash, it does not completely eliminate risk.
Even more important, however, is to invest in a disciplined manner. In a market downturn, sooner or later there will be a recovery. However, if you panic in the midst of a downturn and abandon your investment strategy, you could not only lose out, but also miss out on the recovery.
Determine your risk profile
A critical question you should ask yourself is, «How much loss can you handle?» This question is of great importance because you want to have as many stocks in your portfolio as possible over the long term. However, you should only hold as many stocks as you can during downturns according to your investment strategy. This can be a challenge.
For this reason, at True Wealth, we conduct risk profiling with all of our clients. This process is not complicated and takes very little time. You can do it online even if you are not yet a client. A test account allows you to try out risk profiling for yourself at your leisure.
Stocks can offer attractive long-term returns, but they also come with significant risks. Diversifying your portfolio and following a disciplined investment strategy are key components to protect yourself from stock market turbulence. In addition, it is critical to know your personal risk profile in order to tailor your investment decisions accordingly.
Do you have any questions or comments? Feel free to send an e-mail to Felix Niederer. See you soon!