The foundation of Stack Financial Management’s investment philosophy is a belief that portfolio construction must be based on a thorough assessment of market risk. With careful attention to the historical forces that move the market, SFM utilizes a “safety-first” approach to investment management.
Our respect for risk in the pursuit of profits has led to the evolution of the investment methodology which we employ in constructing portfolios and selecting securities. Many other firms profess the ability to forecast market turning points. At Stack Financial Management we are focused on following the weight of the evidence and allowing an objective assessment of the data to dictate our risk management strategy.
Our primary objective is to maximize long-term returns in a manner that reduces volatility and emphasizes preservation of capital. Through careful asset allocation and security selection, our goal is to provide an opportunity for superior risk-adjusted returns over a full market cycle.
Damaging Power of a Bear Market
Most investors are familiar with the concept of Compounding Interest. It is one of the simplest but most powerful forces in all of investing. However, most investors fail to realize the damaging power of “reverse” compounding. For example, a -20% loss requires a gain of +25% to get back to even – as losses become more extreme, so does the effect of reverse compounding. This is an important concept as it pertains to an investor’s life cycle.
For a young investor with a long-term horizon, a simple buy-and-hold investment approach and a consistent plan for saving and dollar cost averaging can harness the power of compounding interest. A younger investor can afford to be more aggressive because they have time on their side to recover from large portfolio drawdowns. Comparatively, individuals who are near retirement or no longer working are not afforded the same luxury, as they have significantly less remaining earning power and a shorter time horizon to recover from portfolio losses. For these investors this means a bear market can significantly alter one’s life in retirement. This is why the foundation of our investment philosophy is risk management – the idea that there is a time to allocate more assets to equities, and a time to reduce portfolio exposure when equity market risk is high.
The above chart outlines the destructive nature of a bear market:
- A 40% loss is not 2 times worse than a 20% loss…it is 2.5 times worse!
- A 60% loss is not 3 times worse than a 20% loss…it is 6 times worse!
- An 80% loss is not 4 times worse than a 20% loss…it is 16 times worse!
Minimizing losses in a bear market is critical to the long-term success of your investment portfolio. At Stack Financial Management, we strive to keep bear market losses to half or less of the overall market decline.