Drawdowns and how they impact your investment?

Drawdowns can present very significant and devastating risks to investor’s portfolios when considering the returns required to fully recover from a loss. The underlying fund in the investment will determine the potential drawdown that an investor may be faced with. It is important to remember that with higher returns comes higher risk and the potential for greater losses.

Let us look at the following example:

Investor A has an investment that declines in value by 20%. In order to for Investor A to get back to his starting point he would require the investment to rise by 25%.

Investor B is invested into a fund that decreases by 50%. Investor B now requires a return of 100% on his current investment value simply to recover from the drawdown he has suffered.

The below graph illustrates just how important it is to avoid substantial drawdowns in your investment.

Diversification

Diversification is an investment risk strategy which manages and blends different investments within a portfolio. Investment managers attempt to construct investment portfolios which are made up of equities, bonds, property and cash instruments to mitigate against the risk of potential drawdowns in a portfolio.

Diversification offers an additional layer of protection as not all assets react the same in similar market conditions. Over the past few years there has been heightened volatility in the stock market which should give investors cause to assess how are their investment portfolios positioned and how they can diversify their portfolio to mitigate against any potential drawdowns.

Investors should consider the amount of risk they are willing to take in their investment and what the impact would be to their future savings goals or plans if the investment were to suffer from a drawdown. It is important to remember that a drawdown does not necessarily imply that there is a loss. Markets go up and down and investors would only realise a loss should they disinvest from the fund. This being said it is very important for investors to try to avoid as much as possible large drawdowns so as to maximise their long term investment returns.

For more information on how to diversify your investments or to find out more about drawdowns, diversification and the impact this can have on the outcome of your investments please contact us to discuss your portfolio.

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