Risky Business

The recent market volatility and decline has been disappointing and has highlighted the problem with “drawdown” risk; the risk of a decline in portfolio value from a recent high.  Other measures of risk like standard deviation of return measure the statistical volatility of returns, but drawdown risk is more easily understandable and observable (and hurtful!)

As seen from the bottom half of the chart below, we have seen a recent drawdown in the S&P 500 (IVV, the green line) of -8.3% drawdown from a recent high and a maximum drawdown experienced during the last twelve years of -33.8% due to the COVID outbreak in March of 2020!  But, the offset to this is that IVV has also shown a cumulative total return over this 12-year period of +390.5%; one could argue that is a fair tradeoff of return versus risk.  Other less risky portfolios that include varying allocations to bonds, like the iShares Core Aggressive ETF (AOA), iShares Core Growth ETF (AOR), and the iShares Moderate ETF (AOM) have shown less drawdown and a commensurate lower total return.  The portfolio with the least risky profile, the iShares U.S. Aggregate Bond ETF (AGG, the blue line towards the bottom) as a 100% investment grade bond portfolio, has shown very low risk and the lowest return.

As I have recounted many times, for clients that have a long time horizon with sufficient income and net assets to cover their lifestyle and can tolerate the potential for large drawdowns, a portfolio with a large allocation to equities has proven to be an effective strategy to earn higher total returns during this time horizon.  Clients with a shorter time horizon or unique circumstances are better off maintaining a portfolio with reduced equity exposure to target a “smoother” ride shown by the portfolios with reduced equity exposure (AOA, AOR, or AOM).