Do you try to outperform the market? I have friends, and potential subscribers, frequently ask me “Can you consistently outperform the market?” I think I shock many of them when I answer, “No, I can’t”.
Then I have to explain “that is not the goal. I want to grow my portfolio over time. I have underperformed the market 6 out of the last 10 years (2002 thru 2011), but over that time period the S&P500 is up 34% and the AAAMP portfolio is up 120%”.
Instead of Trying to Outperform the Market: Be Risk Adverse
Many investors believe in a static buy and hold asset allocation but I believe a tactical asset allocation based on valuation is far superior. I only want to invest my money when the odds are heavily in my favor. Many times that means holding a large percentage of cash when investment assets are expensive.
It’s important to understand how compounding works. You can make 14% per year for 5 years in a row, but if you lose 50% the 6th year you have lost money and wasted 6 years that your portfolio could have been growing.
Once you lose your money it’s no longer there to make you money. That is why the more you lose, the amount needed to break even grows exponentially. As an example, if you lose 10% of your portfolio, it takes an 11% gain to break even, but if you lose 50% it takes a 100% gain to break even. Take a look at this break even chart.
Break Even Loss Analysis Chart
|If You Lose:||Gain Required to Break Even:|
In addition, you cannot forget the time period factor. Many portfolios have made little or no progress for 12 years! They will never be able to make up the lost time or the potential value of their portfolio, even if a bull market begins today.
This is why long term investors should stay disciplined and focused on a risk adverse investment strategy. My favorite strategy is based on capital preservation and growing wealth slowly. Yes, investors must take risk; but risks should be chosen carefully based on fundamentals and valuations.
The risk in the bond market is the highest in history. The risks of the stock market have only been exceeded by 2000 and 2007.
Both of these periods preceded 50% declines. I’m certainly not predicting a 50% decline. Unknown events could cause the market to go straight up from here. But current fundamentals and valuations dictate a very conservative asset allocation.
This means, don’t make your goal to outperform the market. That will only cause you to make mistakes. The goal is to build wealth little by little over a long period of time.
The best way to outperform the market in the long run is to not lose your investment capital. Use value investing and the principle of margin of safety to build wealth over time.
Related Reading: Portfolio Risk Control Strategies: Focus on What You Can Control