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White paper — The Defined Risk Strategy — A Full Market Cycle Strategy

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Investment Strategy for the Long-Term Investor

Long-term invest­ing means investors will expe­ri­ence full mar­ket cycles. So, shouldn’t your invest­ment strat­e­gy be designed for full mar­ket cycles?

Aver­age investor behav­ior, well-doc­u­ment­ed by Dal­bar, Inc. and oth­er researchers of the years, often con­flicts with investor goals and aspi­ra­tions.

Why?  A major rea­son is that investors’ emo­tions and reac­tions to loss and gain cause them to make invest­ment deci­sions cause them to trail the total return of the invest­ment or index they ini­tial­ly sought to cap­ture. Behav­ioral Finance is a grow­ing field of study with­in finance ser­vices and invest­ment man­age­ment, and for good rea­son, as the mar­ket­place seeks to answer why the typ­cial pro­posed long-term invest­ment strate­gies are leav­ing investors behind…

A Better ‘Buy-and-Hold’ Strategy — Built out of Necessity

Randy Swan, Founder and Lead Port­fo­lio Man­ager of the Defined Risk Strat­e­gy (DRS), designed and launched the strat­e­gy in 1997. As the say­ing goes, “Neces­si­ty is the moth­er of inven­tion”, Randy had a desire to reduce his own loss­es as an indi­vid­u­al investor. Yet there was noth­ing in the mar­ket­place that sat­is­fied the ‘neces­si­ty’ Randy sought to address. After years of work­ing as a senior man­ager for KPMG’s Finan­cial Ser­vices Group, pri­mar­i­ly work­ing with risk man­agers and insur­ance com­pa­nies, Randy bring risk man­age­ment to the realm of invest­ment man­age­ment in the form of the DRS.

The Defined Risk Strat­e­gy seeks to direct­ly address mar­ket risk, or ‘sys­tem­at­ic risk’, in port­fo­lio con­struc­tion or as Randy puts it, he was “seek­ing to not lose big”.

Long-term invest­ment involves set­ting a goal some time in the future.  Typ­i­cal­ly, over any long term peri­od (10 years or more), the mar­ket will expe­ri­ence mar­ket cycles con­sist­ing of both a bull mar­ket (sus­tained peri­od of ris­ing mar­ket val­ues) and a bear mar­ket (peri­od with mar­ket val­ue loss of 20% or more). Randy was seek­ing to find a bet­ter way to remain invest­ed in equi­ties (the asset class with the high­est long-term returns) through mar­ket cycles, for him­self and his fam­i­ly and friends, in order to avoid or reduce the emo­tions and math­e­mat­i­cal impacts of major loss­es upon long-term invest­ment goals.

As such, the Defined Risk Strat­e­gy is designed with the investors’ best inter­est woven into the fab­ric of the strat­e­gy.

In this paper Randy pro­vides a brief overview of the strat­e­gy he designed as investor, with the best inter­est of the investors at heart. Then Randy pro­vides a con­trast to typ­i­cal long-only, or “buy-and-hold”, strate­gies.

 

Orig­i­nal­ly pub­lished March 2013. Updat­ed June 2016.