Understanding Market Declines: Accepting Drawdowns as Part of Your Equity Journey
As investors, we are often captivated by the potential for growth and success in the stock market. We envision our portfolios soaring to new heights, maximising our returns, and achieving financial freedom. However, it is crucial to have a realistic perspective on the market and acknowledge the inevitable declines that come with investing in equities. In this article, we will explore the significance of accepting drawdowns as part of your equity journey and how aligning your expectations can lead to more confidence and better decision-making in the long run.
To illustrate the frequency and magnitude of market declines, let’s take a look at a chart provided by Fundsindia.com
The chart showcases the annual declines in equity markets from 1980 to August 2023. Within this 43-year period, it is evident that no year has been immune to a fall in the market. In fact, only three out of the last 43 years experienced intra-year declines of less than 10%. Those exceptional years were 1984, 2014, and the current year, 2023.
The average decline across this 43-year spectrum is 21%. This statistic alone should highlight the importance of aligning our minds with the reality of drawdowns. While we may occasionally experience milder declines of around 10% in favourable years, it is unrealistic to expect that we will never encounter a decline or have one limited to just 1-2%. By acknowledging that drawdowns are a natural phenomenon of the market, we can set ourselves up for a more informed and resilient investment journey.
It is important to note that nobody enjoys witnessing their portfolio’s value decrease. As human beings, we naturally prefer growth and positive outcomes. However, our aversion to declines does not change the reality of the market’s fluctuations. Just like we cannot prevent ourselves from growing older each year, we cannot halt the occasional downturns in the stock market. Thus, it becomes crucial to align our expectations with reality.
By embracing drawdowns as an integral part of our equity journey, we can develop a more comfortable and accepting mindset. This is not to say that we should become complacent or passive in our investments. On the contrary, it empowers us to make more informed decisions and manage our portfolios more effectively. Understanding that drawdowns are a normal occurrence allows us to devise strategies to navigate through them successfully.
Reducing drawdowns and achieving outperformance during market declines can be pursued through various investment strategies. Momentum strategies, for example, aim to capitalise on upward trends and minimise exposure during downward trends. However, for newer investors, the first crucial step is to accept the presence and possibility of drawdowns. By viewing drawdowns as an expected part of the journey, investors can develop resilience and avoid rash decision-making during volatile periods.
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