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Seeking Returns Is a
Risky Business

Why does anyone invest? To turn money into more money – fair enough. But let’s get more fundamental – what’s the goal of investing? How can investment success be measured? Many investors think of returns as the best indicator that a strategy is paying off.

It feels good to chase wins, and not just in investing. But when an investor thinks about their portfolio in this way, they’re missing an important part of the puzzle.

Markets move up and down, and investments will move with them to varying degrees. In a perfect world, an investor would want their investments to faithfully track the market in boom times (in other words, an “upside capture” ratio of 100%) but not follow the market whatsoever in a downturn (a “downside capture” ratio of 0%).

Of course, we don’t have access to these kinds of perfect investments in this world. (If you do, you can stop reading here!) An investor may think that the ideal capture is 100%—yes, they’ll have to swallow some losses in the bad years, but at least they’ll get the full benefit of market upswings.

But actually, while it may seem counterintuitive, capturing less of both the upside and the downside of market movements may leave an investor with better long-term returns overall.

To help understand why, imagine a really catastrophic day in the markets, where a portfolio loses 50% of its value. To recover, an investor would need to gain 100% to compensate for the loss – and then even more than that to deliver a net positive.

So if an investor has to choose between capturing big gains and avoiding steep losses, the second priority may be, if anything, more important than the first.

With this in mind, an investor should consider taking a look at their portfolio with an eye to seeking downside protection. The right approach is something an investor will need to evaluate within the larger context of their portfolio (for example, if they’re overweight equities, they can consider adding duration exposure).

Another set of products worth exploring are ETFs that are designed to minimize volatility. If an investor doesn’t experience nerve-wracking drawdowns, it may help them stay in the market long-term – an important driver of successful investing, as the chart below illustrates.

Missing top-performing days can hurt your return

Hypothetical Investment of $100,000 in the S&P 500 Index over the Last 20 Years

Hypothetical missed investment returns chart
Sources: BlackRock; Bloomberg. Stocks are represented by the S&P 500 Index, an unmanaged index that is generally considered representative of the US stock market.
Past performance is no guarantee of future results. It is not possible to invest directly in an index.
For illustrative purposes only. The graph above shows how a hypothetical $100,000 investment in stocks would have been affected by missing the market’s top-performing days over the 20-year period
from January 1, 1996 to December 31, 2015.

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