Recovery Risk

I had just turned 16…Armed with my newly acquired driver’s license, I was dying to secure a date with Cecilia. She was drop-dead gorgeous and I wanted to see how she looked over a shared-pizza. 

I can still recall the incredible anxiety as I dialed her number.  Looking back on it, the equation was simple – risk the embarrassment of rejection for the possible reward of Cecilia’s company.  Ending the suspense of the story, the pizza was lousy but the company was memorable…

Though we’d all like to have a “free lunch”, life and investments simply don’t offer many.  In order to secure a reward, some degree of risk must be assumed.  

Let’s Talk Risk…

Risk can be defined in many ways. When assessing risk in any type of investment, it’s essential to consider the “recovery” risk.  Let’s take a look at that…

What is Recovery Risk ? Recovery risk is the uncertainty of whether an investment will recover from losses and, to a lesser degree, how long the recovery will take.

It's a fact of life......... all investors, traders and  money managers  endure times when losses are posted.  These losing periods - often referred to as “drawdowns”- are simply a normal part of the long-term performance of any investment.  Understanding that drawdowns are a normal occurrence, the uncertainty of what happens after the drawdowns ends creates a risk factor.  This “what happens next” uncertainty is what we term as “recovery risk”.

Successful money managers have one thing in common – when drawdowns occur they ultimately arrest the losses, turn things around and get back on the road to profitability. The ability to recover from losses (and, to a lesser extent, the time it takes for the recovery to occur) is what separates the winners from the losers. This is one way to view "recovery risk".

Exactly how much "recovery risk" should you assume in any investment?  That decision is different for each person.  Ultimately, it goes back to understanding your inner balance between risk and potential reward. 

Investment decisions involve many variables.  The degree of recovery risk in any managed investment is merely one more thing to consider.  It’s an important element in the decision making process however and thus, it should be a part of the “do I invest or not”  evaluation process.

Suggestion…If you’ve weighed all of the variables and decide to enter a managed investment, you should stay the course!  When drawdowns come (it’s inevitable that they will), you must exercise patience and allow a reasonable amount of time for the drawdown to be reversed. Prematurely bailing out of an investment (deciding there won't be a recovery before you have evidence of that fact) is a common and often financially painful reaction.