Since their peaks in Oct/Nov 2021, high growth stock prices have been hammered much more than the major indices. It’s typical for growth to outperform in bull markets and underperform during bear markets. As I’ve said many times, with a concentrated, high growth portfolio, one should expect at least a 50% drop at some point. It really is inevitable, and it will happen multiple times during a multidecade investing career. But suffering the big downs is the trade-off for attaining a higher long-term CAGR assuming, of course, that we can pick the right companies to buy. So, the game for me has been to try to optimize for the highest long-term CAGR on my entire portfolio. Along the way, there have been periods during which my portfolio experienced very large drawdowns of >60%, including in 2000-2001, 2008-2009, 2015-2016, and now 2021-2022. Since we don’t know when these bear markets will occur, it makes sense to stay invested knowing that in the long run the CAGR will outperform the market.

Now, let’s question the premise that it’s always better to maximize the long-term CAGR. Let’s take two people in different circumstances.

The first person is employed with many years from attaining financial freedom. The optimal path to the goal of financial freedom is to maximize CAGR. Mathematically, the highest CAGR will get her to her goal the fastest. Remaining fully invested and continuing to invest excess savings on a regular basis avoids the issue of having to correctly time the market which is very difficult.

The second person is a retired person who is already financially free (i.e. he doesn’t need to trade time for money in order to meet spending requirements). This second person has enough assets and/or cash flow to cover all expenses for his remaining years. Should this person continue to invest aggressively in order to maximize CAGR or should he adjust his approach to limit downside should the next bear market appear? There’s really no correct answer as the priorities and goals are personal. However, if someone is already financially free then he can choose a lower CAGR in exchange for lower volatility and a higher assurance that he won’t ever drop out of financial freedom. So, this second person’s decision on how to allocate is not as straight forward, and there are more nuances.

Rather than prescribe how others should prioritize their objectives and/or how they should allocate their assets, I’ll pose some questions that could provide more clarity. Each person’s answers will be different which will make their priorities different. In turn, their allocations will ideally reflect these priorities and the individual’s circumstances.

Are you striving to become financially free or are you already financially free?

If your goal is to become financially free, how close are you? If you’re already financially free, how much of an asset buffer do you have? These are important questions. If a working person is only a handful of years away from projected financial freedom or if a retired person has just barely attained financial freedom, then they may not want to risk a major drawdown which could set them back a few years or force them back into trading time for money. Framed another way, how bad would it be for someone who was hoping to retire in two years to get hit by a bear market causing their timeline to get pushed back by three years? For some this would seem intolerable and for others it would be no big deal. Or, for someone who’s retired, how bad would it be to have to return to the workforce for a few years? Different people will have different answers and different preferences. Some might consider their financial freedom as provisional which enables them to psychologically endure higher volatility and achieve a higher long-term CAGR. 

How much do you need and what will be done with the leftover assets when you are gone?

Asking oneself this question can be enlightening. Going through the estate planning process forces one to specify to whom the excess assets will be bequeathed. If your calculations project that you will have enough until your last day but little more, then you might determine whether you want an extra cushion should your projections for return on assets and/or future expenditures fall short. Or, you may want to leave your friends, family, or favorite charity some of your remaining assets. Giving the above some deep consideration will probably clarify how you want to balance your security, risk, and volatility. At the very least, you will see for whom you are investing: additional asset buffer, your heirs, or your community (charity). 

On an emotional level, how do you handle the volatility?

It sure is easy when your assets are increasing. Everyone feels like a genius when they’re getting wealthier. There’s been quite a run up over the past few years. Unfortunately, markets don’t go up in a straight line forever; there are corrections and bear markets in between, and some of these can be quite brutal. Many people may not really know how they would feel about a 60%+ drop until they actually experience one. We’re in the midst of one of the worst drawdowns so it’s a good time to assess if the emotions triggered by financial loss have spilled over into other areas of life. Maximizing CAGR is great but if the drawdowns cause significant harm to mental health or other important areas of life then maybe the investments are too aggressive. On the other hand, if someone is able to take the drops in stride, then maybe maximizing CAGR is appropriate. However, these emotional responses can change if there have been changes in one’s life. A 60% drop in 2000/2001 may have felt differently than a 60% drop in 2008/2009, and the same percentage drop may feel different today. We get older. We gain more assets/wealth. We have different financial obligations to others like children, partners, or parents. We may have more or less willingness to work for money. Circumstances change over time, and it’s important to remain aware of these circumstances for they may influence not only our priorities but our emotional response to loss. Any change in circumstance can be a reason to how one is playing the game and ideally such changes should lead to a portfolio adjustment.

Do you think in percentages or dollars?

When looking at my investments, I’ve become accustomed to looking mainly at the percentage return rather than the dollar value increase or decrease. After all, when maximizing CAGR and when striving for financial freedom, one is still working for income and contributing new dollars to the portfolio. Thus, one is on a journey toward achieving his/her financial goals and probably not thinking too much about what those dollars mean or what they can be used for. Focusing on the percentages can keep one zeroed in on the companies and their fundamentals so evaluation of good/bad investments is not muddied by thinking about how much money can be made or lost. On the other hand, looking at the dollars can induce feelings of greed or fear that can be counter-productive when trying to focus on making good investment decisions. But ultimately the dollars are for spending or giving away. After successfully investing for a long period while living below one’s means, the dollars accumulate and can grow to a large amount. Only thinking about the percentages can serve the purpose of focusing the mind on making the right investment choices rather than focusing on how many dollars might be lost or gained. But thinking this way also can lead to a sort of tunnel vision making a person “blind” to the amount of money that one is up or down. At some point, the dollars become very significant maybe even providing a significant buffer (i.e. you have attained more wealth than you will need and you are now growing the assets for the charities). If someone finds themselves in this position, then perhaps they can ask themselves a tradeoff question: would you rather have a fairly certain 5-10% return or would you rather have an average 20-25% return with the chance of a 50-80% drawdown? In this case, it helps to think in dollars, not percentages. Again, there is no right answer, but it’s a worthwhile thought experiment. 

How quickly have you attained your wealth?

For some investors, 2020 and the first three quarters of 2021 showed phenomenal returns in their portfolios. Personally, my net worth grew by more than 500% in less than 21 months. When success comes so quickly, one can get caught up in the excitement. More important, the answers to many of the above questions may have changed as a result of the rapid appreciation. If one doesn’t continuously monitor the changing circumstances and periodically re-ask the questions then one is unlikely to make the necessary adjustments to align allocations with new priorities. It really helps to think about possible future circumstances, hypothetically ask the above questions under various possible changing circumstances, and plan for when and how adjustments will be made. Then one can be ready to promptly make changes to objective and strategy.

Matching Allocations to Priorities/Objectives

Your game can change and perhaps your game should change when your priorities and the resulting objectives change. I’ve been a growth investor for most of my life and for much of that time I’ve been close to 100% invested in growth stocks. While this approach has served me well with a high CAGR even in spite of the periodic large drops, I’ve recently been rethinking my own game. I am older. The prospect of returning to a life of trading time for money is becoming increasingly less appealing to me. The dollars in the portfolio have increased significantly, and I’m becoming more interested in preserving what I have than maximizing my long-term CAGR. However, growth stocks will always have a place in my portfolio. It’s the amount that I will allocate to aggressive growth that will decrease as I advance in age and in wealth. I understand that my circumstances and temperament are unique to me, and the approach I use and the adjustments I make may be totally inappropriate for the person standing next to me.

The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.