Why Active Management


It’s important that you understand the impact that a bear market has on your capital. The give and take of your investment capital is not equal. If you placed $100 into an investment and it declined 50% to $50, what is the rate of return you would need to earn back your original investment of $100? Once you lose money, it takes a much greater return on the funds you have left to recapture your original investment. In this case, you would need a 100% gain on the remaining $50 to recapture your original $100 investment. These break-even percentages are shown in the table below, the Mathematics of Declines and Advances. Using the Mathematics of Declines and Advances, the table below calculates previous bear market break-even points and highlights the painful effects that a declining market can have on your investment capital.


Let us explain how this is possible. In the following table, we calculate the minimum return needed to break even with an actively managed strategy as compared to a buy-and-hold strategy. The active strategy never loses money in any year. When the market has a negative year, the active strategy has a 0% or no loss year. So if the active strategy never loses money in the negative years, what percent of the gains does the active strategy need to capture in the positive years, to equal the same average rate of return as a buy-and-hold strategy? We also calculate the break-even point needed if your losses in the down years were half the losses of the buy-and-hold strategy. The table below displays the year-to-year results of this analysis.



If you never lost money in the down market years, you would only need to capture 38.33% of the gains in the positive market years to equal a buy-and-hold position in the Nasdaq 100 index. More realistically, if your losses in the down market years were half the Nasdaq’s losses, you would only need to capture 63.37% of the Nasdaq's gains in the positive market years to equal a buy-and-hold position.

The point we are making is that you don’t need to equal or outperform the performance of the market in the positive market years if you protect your capital in the down market years. Protecting your capital in the down market years has an exponential effect on growing your capital over time. The objective with any money management strategy should be to reduce risk and maximize returns - with risk reduction being the most important factor. All other things being equal, you want to invest in the least volatile, highest reward, lowest risk strategy possible.

You may be reading this today because you are tired of giving all of your own assets, or your client’s assets, away to a bear market. You may even be in the position where your retirement has been diminished to the point of having to change your retirement plans. Whatever the reason, you have probably come to the conclusion that there is another way to grow and protect your assets. ProfitScore® Capital Management would welcome an opportunity to learn about your financial needs and discuss how we can help you achieve your financial goals.