We’ve all heard of the buy-and-hold investing strategy, where investors purchase assets such as stocks, mutual funds, and index funds and hold onto them through market fluctuations. This strategy is rooted in the Efficient Market Theory, which asserts that stocks always trade at their fair market value on exchanges, implying it is nearly impossible to outperform an overall market through market timing or stock selection.

What if I told you that we believe there’s a more suitable way to invest, one that seeks growth and preservation of your money? While it can be difficult to outperform an index such as the S&P 500 on the upside by picking individual stocks while maintaining a well-diversified portfolio, what’s often overlooked is the value of downside protection.

Let’s say your portfolio goes down 10%. To get back to break even, you need just over an 11% increase. Seems manageable, right? That’s because, for most people, it is. Now imagine you lose 25% of your portfolio’s value. You’ll need a gain of roughly 33.4% to get back to break even. Now, it’s getting less manageable. What if you’re dealing with a 50% market crash? Nothing short of a 100% move higher off the market low will get you back to break even—and this could potentially set you back years.

If you’re retired and rely on your portfolio to supplement your income, a 50% market correction likely puts you at a significant risk of running out of money. What was once a relatively sustainable 4% annual draw on the value of your portfolio doubles. This means you would need to earn a minimum of 8% every year just to keep your portfolio from dwindling. What if an unexpected expense pops up that requires you to withdraw additional funds from your investments? You’ve now exceeded that 8% draw, setting you back even further.

Here are four of the more significant corrections the S&P 500 has experienced in the last 25 years:[1]

• 3/24/2000 – 10/9/2002: -49.1%
• 10/9/2007 – 3/9/2009: -56.8%

The above period is known as “the lost decade,” where significant market downturns led to extended periods of poor returns, severely impacting investors’ portfolios. Following the lost decade, the market continued to face several notable corrections beginning in:

• 2/19/2020- 3/23/2020: -33.9%
• 1/3/2022 – 10/12/2022: -25.4%

How much of the downturn did you experience during these corrections? Consider the impact if you were able to avoid 60% of the move lower. How much more money would you have today?

Let’s look at another example. If you had invested $10,000 in an S&P 500 index fund in 1960 and made no additional contributions or withdrawals, by the end of 2020, your portfolio would have grown to over $628,000.

Now, what if you had an actively managed portfolio—one that achieved 40% of the S&P 500’s declines and captured 80% of the upside? You would have over $823,000. That’s nearly 31% more money in your portfolio, without having to beat the S&P 500 even once over those 60 years. Instead, you limited your losses.

So, what are your options? Are we all supposed to put 80% of our money into an index fund and periodically sell half based on a “gut feeling” or what the “financial experts” are telling you on TV?  We believe that’s probably not the best strategy. Letting your feelings get in the way and cloud your judgment can be one of the biggest mistakes you can make when investing.

Our answer lies in a rules-based process that uses data to help you make decisions. Relying on a combination of fundamental, technical, and market signal data, our approach helps you to objectively evaluate opportunities and risks. Focusing on forward-looking data is crucial to this approach. While historical data can teach us a great deal about markets and how they may react to certain data points, it is much less important when it comes to effectively risk-managing your portfolios moving forward. Instead, look at the current data trends of today and anticipated releases over the next several months—not what happened last week. If you aren’t positioned appropriately when the data comes out, it’s already too late.

Another challenge in risk-managing a portfolio without access to forward-looking data involves distinguishing between what may be a normal correction (which may happen several times within a year) and what may be a longer-term trend. This differentiation is important for many reasons—the most significant of which is the impact it has on portfolio strategy. If the data indicates a likely long-term downward trend, a repositioning of a portfolio is needed, while a short-term correction may not require drastic changes.

If you make the mistake of selling into what could be your normal 5-10% move lower, you may miss out on valuable upside capture in your portfolio as you attempt to work yourself back into the market. Or worse: if you sell in a bear market and it unexpectedly rebounds with one of its infamous ‘bear market bounces,’ where the S&P 500 goes back up in just a few short weeks, you might panic and buy back in at a higher price, only to have the index potentially put in another wave lower the following week. Now, you just sold low, bought back high, and will likely sell low again. This costly cycle commonly happens when you lack the data necessary to distinguish between a normal correction, a bear market bounce, or a plain old bull market.

Adding even more complexity, various asset classes, such as utilities, REITs, technology, and industrials, as well as factor exposures, like small-cap stocks, international, and large-cap entities, tend to perform differently depending on the prevailing economic environment.

We’ve all heard someone say at one point or another, “Only invest what you are willing to lose.” I could not disagree more. While investing generally has some varying level of risk involved, adopting a strategy where you only invest what you are willing to lose significantly limits your potential of ever achieving your financial goals in the stock market

Investing can be challenging—especially in a world where artificial intelligence and high-volume computer algorithms can cause enormous market fluctuations in a very short time. For that reason, we believe it has never been more important to partner with a trusted advisor who uses a rules-based process and will seek to protect and compound you and your family’s wealth over time—so you can aim to achieve your financial goals.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

[1] https://yardeni.com/wp-content/uploads/BullBearTables.pdf