by Jason Wenk

Often times when the stock market zooms investors get complacent.  Money managers too.

What seems to happen is we forget very quickly how painful it is to have markets fall and our accounts drop in value and we instead get filled with euphoria about market rallies.  In fact, if we don’t see our money going up as fast as the market we often are disappointed even though we may be experiencing nice gains.

This is a problem, and I’ve got some statistics for our readers to chew on next time they find themselves falling for this investor trap.

The trap is thinking market gains is more important than protecting from market losses. To be sure, protecting from market losses is far, far more important than catching 100% of every market rally.  Here’s the proof:

S&P 500 - 25 Years Ending 12/31/2009 - Average Annual Return 7.93%

Source: Hepburn Capital Management 2009 study

As you can see, avoiding the worst days not only helps produce the best returns, it’s also a lot easier on the stomach – even if you make nothing on the markets best days.  And if you miss both the best days and the worst days: you still perform better overall than the market and do so with much less risk.

Based on these facts one could surmise that managing investment risk is the most important thing for both money managers and investors to focus on.

So next time you see yourself lagging the market in a rally, keep in mind that missing the big gains is really not nearly as important as having a strategy designed to miss the worst times too.

Note: This is a hypothetical example and there’s never been an investment strategy that missed just the best and worst days of the market. This study also doesn’t take into account management or trading fees that might be incurred in implementing such a strategy. Nor can you invest directly in the S&P 500 index.