Why Do We Focus on Risk?

Performance reports often boast impressive one-year, three-year, or five-year returns, but these time periods can be deceiving. While short-term gains may seem remarkable, zooming out reveals the potential for a completely different narrative. We call this phenomenon terminal point bias. It’s essential to remember the timeless adage: past performance cannot predict future outcomes.

Additionally, the performance itself is only one-half of the equation. A great performance can come with great risks, and many investors, especially those near retirement, cannot afford such risks. Investors should not only focus on the typical measure of risk, i.e., volatility, but also incorporate drawdown into their investment decisions. Drawdowns help investors determine the greatest loss they are willing to tolerate and work in conjunction with the math of loss to give investors an idea of how long it may take for their portfolios to recover. As investors may recall, taking distributions amid a drawdown further inhibits the recovery of a portfolio.

“Lost Decades” since 1928