I made probably one of my worst investing mistakes during the downturn of the pandemic. I had all the excuses to say that it wasn’t really my fault but the timing and pulling the trigger was mostly my own decision. The point more is what I can learn from the loss as well as focus on the small wins I also had while realizing a big loss.
My big loss was rooted in my divorce agreement. Around the time the pandemic hit, I had agreed to pay out a fixed portion of my IRA which was rolled over from an old 401(k). As the market tumbled, government, the media and investors freaked out. I was not freaking out, yet. February and March progressed though and the market turned to a bear market, I watched my IRA dwindle Im value. I thought back to the time during the crisis when the market fell as much as 50% so cutting my losses at 25% or 30% seemed like somewhat of a win.
I also took into account the fact that some of those funds had been invested since as early as 2008 so there was still a lot of gains in that fixed portion I would be ceding to my ex wife. When things seemed like they would not be getting better in March, I pulled the trigger and sold near the bottom of the market to extract the settlement amount before things got worse, then something happened.
In the time it took to settle other issues with my divorce negotiations, the market roared back and almost recouped all the money that had been lost. The fixed portion I had to pay was around 20% of my portfolio but I calculated that my decision to sell at the bottom of the market cost me another 5% of my portfolio value. What I mean by this is the opportunity cost of my selling at the time I did cost me about 5% of my portfolio. By not staying invested through the volatility, I lost the upside on that 20% I sold which I could have kept for myself.
Posting Wins
I was reminded of my losses when I saw some “big wins” that people have posted on Instagram. I am experienced enough in investing to know that no one has all big wins. Prior to those big wins or even at the same time as those big wins, the same investors had experienced losses, they just choose not to focus on those. But looking at both your wins and your losses is an important part of the learning process and mastering your own psychology to not keep making the same mistakes.
One post in particular I saw recently showed how the investor had made $10,000 in one day. That’s a great return and this particular person took a larger risk that paid off. When your capital base is small and you are trying to build capital fast, you need those big wins in the beginning.
As your portfolio starts to grow, it may be easier to not focus on dollar amounts though. My portfolio regularly varies between dollar amounts of $20,000 to even $40,000 but I stopped watching the dollar amounts years ago. Rather, I stay focused on avoiding locking in losses and making sure the overarching strategy of my portfolio is consistent and intuitive.
My lesson from locking in that loss is that if possible, next time I should dollar cost withdrawal just like many of US dollar cost average our contributions. In fact this is an important part of portfolios during retirement in reverse. We don’t just accumulate funds in the market and convert those funds to cash at retirement. The funds need to be depleted on a dollar cost averaging basis in order to last longer. You can continue to get the advantage of growth even when you are spending your funds as opposed to saving them.
If I had started dollar cost withdrawing those funds, say 2% at a time over the course of a number of months, I would not have saved the whole extra 5% that I lost out on from the rally, but I would have probably shaved that opportunity cost loss to say 2.5% as opposed to 5%.
My appetite for pain doesn’t stop with an analysis like this either. To remind myself how costly mistakes can be, I also calculated what that 5% of my IRA would be worth at retirement. I calculated it would be almost $100,000 in 2020 dollars. In a way, I can look at this as a $100,000 mistake.
It’s not all gloom and doom however. Throughout the market downturn, I continued investing in my current 401(k) as well as my son’s 529 plan. I can make up for lost funds by extra retirement contributions to my IRA and I am currently maxing out my annual contributions to my 401(k). I figured in this time I have contributed around 12% of all I had to give away. I will be fine, don’t shed any tears for me. The skills to earn, keep and smartly invest money will pay you back 10 times over any mistake you make.
Avoiding Losses
What is key in the above analysis of my mistakes and how focusing on mistakes can be so important is how much losses play a part in cumulative return over the long haul. Avoiding losses can be even more important than participating in gains.
I have seen a number of people illustrate how ever bigger gains are needed to come back from losses in your portfolio. For example, a 50% loss in your portfolio will require a 100% gain to get back to even. As losses get bigger, you need ever greater returns to come back from those losses which is illustrated in the chart below.
At a 90% loss, you need a 900% gain just to get back to even. Big losses require ever bigger returns, which is one reason why you may see so many current Robinhood traders trying to hit a grand slam via a micro-cap, illiquid stock or options as opposed to just trying to get the market returns. A 40% gain is great but if it is hiding behind a 30% loss beforehand, you essentially didn’t make anything.
The CFA Institute did an experiment which showcased how avoiding large drawdowns, or the peak to trough losses in the market, can be even more important than generating great returns. This can be measured via the capture ratio. The capture ratio tries to show how much of the losses as well as the gains that a strategy or fund returns.
Their thought experiment looked at 4 different strategies, all based on the monthly return of the S&P 500 for the years from 2000 to 2013, an important data set because it includes the huge drawdown of the financial crisis.
One strategy just followed the S&P 500, called long only. Another captured 75% of the upside in positive months and 25% of the downside in down months, this was called positive asymmetry, this is the technical term for avoiding big losses. Another strategy captured 50% of the positive months and 50% of the negative months, this was called low beta. The final portfolio was called negative asymmetry and captured 25% of every up month and 75% of every down month. The cumulative results can be seen below and showcase the value of avoiding big losses.
Positive asymmetry trounced the long only return by 164% over the period despite the fact that it only saw 75% of the upside in any given month ever. This showcases how important avoiding losses can be as opposed to just seeing big gains.
It’s interesting to note that this portfolio also had better risk adjusted returns as measured by the standard deviation. The volatility was lower for the positive asymmetrical portfolio despite the fact that it had greater returns. The moral of this is not to provide you with a new trading strategy, taxes may take a huge bite out of this strategy, even if it was successfully implemented, but rather to show how losses and risk mitigation can play a huge part in the returns we see from investing.
Conclusion
It would be great if we started to pierce some of the false veneer we all know is there for many investors on social media. Life is not all wins and not all home runs. Be humble, show us some of your losses too, those are also relatable. If many of us were already rich we may not feel the need to share our wins because we may be focused on other things besides money. Part of the advantage of social media is sharing knowledge to help others improve, we do others a disservice by just showcasing wins.
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