The standard equity and bond allocation has been disastrous in 2022.
Investors who do not manage risk and drawdowns, have challenging compounding consequences.
“Without Capital Preservation there is no compounding”
“A compelling narrative fosters an illusion of inevitability.”
Daniel Kahneman, Thinking, Fast and Slow
I launched my book “Invest Like The Best” in February 2021. Maybe this was the worst timed book launch in history. Or the best. It depends on whether you want to measure it by sales opportunity or timely quality advice.
February 2021 was the peak in high risk equities. Take a look at US growth stock ETFs IWO and ARKK. They peaked that month along with Chinese equities, FXI. Markets make opinions, which govern behavior, and markets don’t make new all time highs without the overwhelming concensus being “risk on” bullish!
“Best Investors” have learnt the hard way how extremes in price and crowd behavior can be so dangerous. They have developed their own timeless operating system that gets them through bull and bear markets better than everyone else. That’s what their track record tells you.
Capital Preservation Is Vital And Where it All Starts
Avoiding big losses, or drawdowns, is the first key to “Best Investing.” The chart below shows how difficult it has been to avoid loses for the first eight months of 2022. All the benchmarks below (in squares) have considerable losses.
Without Capital Preservation There Is No Compounding
In investing, everything starts with the optimal investment objective, which is “Capital Preservation and Compounding.” For sure investors understand that no one wants to lose capital, but what is less well understood is that high risk investing leads to volatile returns, and volatility destroys compounding.
One of the key findings of my book, Invest Like The Best, is that in addition to avoiding losses, Capital Preservation is actually a requirement for high compounding of long term returns. Most investors seem to have completely missed the long term performance benefit of low risk investing. Best Investors understand this completely.
Investors who embrace risk may do well for a time but sooner or later they will lose their compounding benefit with a big loss that wipes out compounding or worse. Then they can never compete in the long term with investors who compound. The chart below shows how much difference compounding makes to long term returns.
This Year A Standard Equity And Bond Allocation Has Been Disastrous
From the numbers above, a 60% equity, 40% bond portfolio has lost around 14% before costs so far this year. That does not take account of also falling behind a reasonable compounding objective of say 6%, nor the crucial time it will take to get back to target.
It will now take around 30% to recover the loss and return to the target compounding rate in the next year – assuming no further losses.
Standard portfolio advice for stocks and bonds, without active risk management, means that the modest 6% compounding objective may now be beyond realistic expectations. This is why sizeable drawdowns of capital can result in a permanent impairment of your long term return objective through the loss of compounding.
Investors who do not track risk and drawdowns and demand accountability have failed in their due diligence and are now likely to suffer long term performance consequences as a result.
Best Investing Can Be Made Simple To Execute
To achieve Best Investor results, investors should demand real-time access to the portfolio performance grid shown above. Only then will they know for sure that your portfolio management is fully accountable to appropriate capital preservation objectives. Your capital preservation accountability should be set in advance, so you know what is and is not acceptable when you look at your results and you can take action in time.
Best Investing Made Simple
“Best Investing” does need to address some complex issues, but it can be distilled into something very simple – which can be verified in real time. It then produces a very beneficial outcome if you just stay within the rails shown below.
A Passive Portfolio With A Risk Number Fails Best Investor Criteria
Just because you have calculated a “risk number” and been assigned a portfolio does not mean that you have addressed everything you need for successful investing.
As you can see from my April 29, 2022 Weekly Insights Blog, “Passive” investing is high risk investing as it completely ignores the accountability of capital preservation and opens the door to significant losses. Having a portfolio with a risk number, whatever that really means, is just a different version of high risk passive investing if it does not come with Best Investor metric accountability.
No Passive Portfolio Provides A Silver Bullet That Delivers Best Investor Results. An Unchanged Portfolio Can Become Hostile Quickly.
Correlations within any portfolio are constantly changing which makes your portfolio inconsistent in how it behaves over time. The chart below shows that the correlation between the stocks and bonds has completely reversed from 2020 to 2022. From -0.75 to + 0.6.
Just as the volatility of both TLT and SPY have increased, the volatility of the portfolio has increased even further at the worst possible time. In 2020 the performance of TLT and SPY offset each other, but by 2022 both assets were moving in the same direction which significantly increased the volatility of the portfolio!
The bull market in stocks and bonds over the last 40 years has come to a challenging period in 2022. Passive investing depends heavily on an underlying assumption of a long term bull market. Investors need to consider an upgrade to Best Investing which works well without any unknowable assumptions.
If you’re not already a client of CB Investment Management, sign up today for a free consultation. Don’t waste your time or money any longer. Let me use my expertise and proven track record to transform your portfolio and transform you to a Best Investor.
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