Most wealth management firms in the United States subscribe to an investing philosophy called “modern portfolio theory.” In layman’s terms, that’s the idea that diversifying your holdings across multiple sectors will minimize losses and produce long-term gains. It relies on historical performance to predict what will happen in the future.
It worked for years, but it won’t fly in a post-pandemic world. Bringing the world to a complete shutdown has reset the clock. Those “historical trends” can’t be relied upon anymore. Investing in the new normal requires a more tactical approach, one that minimizes losses while they’re occurring, rather than waiting for the next uptrend to begin.
What does the term “drawdown” mean for investors?
Investopedia, which is great source of information for investors, describes “drawdown” as a peak-to-trough decline in an investment during a specific period. Think about those line graphs that your advisor shows you. The “peak” is the high point. The “trough” is where it bottoms out. That drop is known as “drawdown.” It’s why your portfolio is showing losses right now.
Modern portfolio theory (MPT) advocates for a certain tolerance towards drawdown because a loss in one sector should be offset by gains in another sector. For instance, technology stocks could be down, but perhaps manufacturing stocks are up. Prior to 2020, when we were in the middle of an eighteen-year bull market, that would have worked.
A bull market is when the S&P 500 shows consistent gains over an extended period. Have you looked at the S&P performance this year? It’s down 17.18% year-to-date. That means ALL sectors are suffering. MPT is a passive investment strategy where advisors don’t make changes, other than rebalancing the sector mix. There’s no mechanism in place to minimize drawdown.
How does Tactive minimize drawdown?
Tactive does not use modern portfolio theory. Our strategy is tactical investing. In other words, when you start losing money to market drawdown, we sell. Our advisors don’t wait for the market to turn around because you’ll be losing money while that’s happening. There are also no guarantees that the sectors you’re relying on for offsetting losses will produce gains.
Rick Dwyer, COO of Tactive and a big Formula One race fan, has a great analogy for this. “Imagine you’re on the racetrack and your team sees that rain is coming soon. You can pit stop and change tires, or you can keep driving, hoping to avoid a crash. The crash is the drawdown. The pit stop is making the change to avoid it. That’s what Tactive does.”
Another flaw with modern portfolio theory is that it leans towards investment models that are made up of stocks, bonds, and ETFs. The classic 60/40 mix of stocks versus bonds has been a mainstay for traditional wealth management firms for decades. What about crypto? Or insurance? Or real estate? These are all wealth building vehicles also.
Minimizing drawdown means adapting to circumstances and using all the tools available to maximize investor returns. That could mean buying Bitcoin or investing in a REIT. Standard investment models at other firms, which are typically rebalanced by algorithms, don’t have the capability to do that. Diversifying across multiple asset classes requires tactical thinking.
Minimizing Drawdown Protects Your Retirement Savings
Let’s talk about how this affects your retirement savings and disbursements. The savings part should be obvious. By minimizing drawdown in the present, you ensure higher returns and a larger balance in the future when you retire. Making the switch to tactical investing now should help make you more comfortable in your golden years.
The second part of this is the disbursement of funds after you retire. Tactical investment management is just as important in retirement as it is when you’re working. Taking out money while your investments are in drawdown eats away the principle of your retirement savings. This phenomenon is known as “sequence risk” and it’s a real problem right now.
Go back to that model-based portfolio your former advisor put together for you. It’s designed to ebb and flow with the movements of the stock market, but everything is going down right now. Withdrawing from that fund today means taking losses and lowering the balance that’s supposed to sustain you for the next twenty or thirty years.
Tactical investing is the answer to this dilemma. Minimizing drawdown with selective trading will help the retirement fund remain solvent for a longer period. Time becomes a major factor after retirement. You’re no longer producing income to build your 401(k) or pension fund. It’s all about stretching what’s there as far as possible. Tactical investing can do that for you.
Accepting Losses is Not an Investment Strategy
Here at Tactive, we don’t use the term “acceptable losses.” Our clients deserve better than that. Some losses are inevitable. That’s just the nature of investing. The extent of those losses can be minimized. We see it as our job to make sure that happens. Tactical investing and utilizing all asset classes, not just stocks and bonds, is how we do it.
The market is hard to predict right now, so tactical investing is critical to success. Getting started with Tactive is simple. Begin by choosing your financial goal, take a brief quiz so we can understand your investment preferences and risk appetite, then set up your account and watch your investment grow. Our system and our advisors will do the rest for you.
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