The best Offense is a good Defense

VTS Community,

"The best defense is a good offense"

I'm sure you've heard this saying before right? The idea that the best path to victory is just to go hard on the offense and the score takes care of itself. And maybe it's true when it comes to football, poker, or chess. I'm not an expert in any of those areas but perhaps it applies there. But in investing I think that's completely backwards. When it comes to investing, in my opinion:

"The best offense is a good defense" - VTS

I've been harping on this point for years. In fact I've built my entire portfolio on the belief that the best path to long term success is remaining consistent and avoiding excessive drawdowns. The reason is simple. Mathematically speaking, losses are far more costly to a fund than gains are beneficial.

 

You can see in that chart, the larger the drawdowns get, it takes an exponentially larger subsequent recovery just to get back to the break even point.

• So if an investor suffers a 10% drawdown it's not the end of the world. They require an 11% return to get back to break even. That may take a few months but it's fine right?

• If they suffer a 30% drawdown, it takes a 43% rate of return to get back to break even. This could take a little longer, perhaps a year or more.

• And a 50% drawdown, now it's going to take a full 100% subsequent rate of return just to get whole again. Remember it took the S&P 500 over 4 years to recover from the -57% crash in the financial crisis. And adjusted for inflation, 6 years!

In this latest coronavirus crash, from peak to trough the S&P 500 dropped -35.4%. Now the S&P 500 has recovered some of that this past week or so and is actually up 19.8% off the lows. That sounds like it's more than half way back right? If it dropped -35.4% and it's now recovered 19.8% of that, seems like it's getting close right? Well, not so fast... Remember the math problem. A -35.4% drawdown requires a subsequent 54.80% rate of return just to get back to break even.

 

Even though it's up about 20% off the lows, the S&P still needs another almost 30% just to break even.

"The best offense is a good defense" - VTS

I've built my entire investing career on the concept of simply trying to avoid those excessive drawdowns in the first place, so that when the markets are stable and calm we are attacking from a much better starting point. 

The VTS Total Portfolio Solution is designed to move to safety in difficult times, so that when things do finally calm down and the market starts marching higher again, we have a huge head start on everyone else who's still trying to dig themselves out of the most recent hole. And since the average recession cycle in the United States is 6-7 years, unfortunately the majority of investors do spend most of their time digging out of drawdowns.

That's not my style. I prefer to just avoid them in the first place if possible. Here are the 6 largest drawdowns in the VTS Total Portfolio Solution since I launched VTS over 8 years ago in January 2012:

 

#1) May 2012: -7.73% drawdown requires a 8.38% recovery. 

- Took the TPS 1 month before making a new all time high.

#2) Jun 2016: -5.62% drawdown requires a 5.95% recovery.

- Took the TPS1 month before making a new all time high.

#3) Sep 2017: -5.00% drawdown requires a 5.26% recovery.

- Took the TPS 5 months before making a new all time high.

#4) Jun 2013:  -4.87% drawdown requires a 5.12% recovery.

- Took the TPS 1 month before making a new all time high.

#5) Jan 2016: -3.78% drawdown requires a 3.93% recovery.

- Took the TPS 1 month before making a new all time high.

#6) Mar 2019: -2.49% drawdown requires a 2.55% recovery.

- Took the TPS 1 month before making a new all time high.

We'll be moving back into the market soon, albeit in smaller allocations because I don't think the trouble is quite over yet. We're still likely to get more waves of bad data coming in and I still don't think it's wise to get aggressive here.

But just like all the other drawdowns in the broad market, the VTS Total Portfolio Solution will have a big head start when we do resume, and that's my overarching investing philosophy.

The reason I've been able to maintain a portfolio that is consistently either at all time highs or at least within striking distance is because of the safety aspect of each strategy. When combined into a diversified portfolio, it keeps the drawdowns to a minimum.

"The best offense is a good defense" - VTS

So when people look at the long term performance of the portfolio, and they see the roughly 20% annualized rate of return, they may assume it's because we are aggressive and make big profit when the markets are stable.

But actually, it's the drawdown reduction that is largely responsible for the long term performance. The best way to get yourself out of a hole, is to not fall in the hole to begin with :)