The Importance Of Low Drawdowns When Investing

The most common investment strategy out there is the one called “Buy and Hold”. It’s popular because it requires no work apart from the initial purchase of your selected share or index fund. So why doesn’t every one use it? 

It’s certainly worth looking at for younger investors with decades of earning power (and therefore contributions into the fund) in front them. Older investors, not so much. A significant market crash just before retirement could decimate a pension or other retirement fund and lead to significantly less regular cash withdrawals available.

The other issue is a psychological one, even for young investors. The vast majority of people can’t withstand the emotions generated by a significant market crash and sell up close to or actually at the actual bottom of the crash.

A market crash is typically defined as a sudden and significant decline in the value of a financial market, such as the stock market. While there's no universally fixed threshold, a few key elements are commonly associated with a market crash:

If the market decline is 10% then it is termed a “correction” rather than a crash. If the market declines by 20% or more then that is called a “crash” Most corrections or crashes happen quite quickly which adds to the panic and decision to sell and get out before further losses are incurred. There are a number of examples of crashes including:

  • The most well known is the 1929 Great Depression: A 23% market drop over two days triggered global economic devastation.
  • Black Monday (1987): A 22% drop in a single day.
  • 2008 Financial Crisis: A prolonged crash caused by the subprime mortgage collapse.
  • COVID-19 Crash (2020): A swift decline of over 30% in major indices within weeks.

Most people sell up before a 10% decline is reached and then either stay out of the markets all together or buy back in when the market has recovered. Both decisions are wrong. You should be buying when the market crashes simply because shares are on sale. Selling is reserved for market highs and not market lows.

This is the main problem with “Buy and Hold”. It has a buy decision but no sell decision. The difficulty is knowing when to sell. Some traders and investors use technical analysis such as moving averages or other well known indicators but most are ineffective due to waiting too late to sell or selling too early. This is why I created the “Five Minute” investment strategy. Clear buy and sell signals and just 5 minutes a year to look at the signals and make the changes to your portfolio.

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