Investors tend to underestimate the volatility of the financial markets.
"From 1916 to 2003, the daily index movements of the Dow Jones Industrial Average do not spread out on graph paper like a simple bell curve. The far edges flare too high: too many big changes. Theory suggests over that time, there should be fifty-eight days when the Dow moved more than 3.4 percent; in fact, there were 1,001. Theory predicts six days of index swings beyond 4.5 percent; in fact there were 366. And index swings of more than 7 percent should come once every 300,000 years; in fact, the twentieth century saw forty-eight such days. Truly, a calamitous era that insists on flaunting all predictions. Or, perhaps, our assumptions are wrong."
Benoit Mandelbrot
"The Misbehaviour of Markets"
In 2006, the S&P 500 had 139 positive days (out of 250 total trading days) adding up to a cumulative return of +90%. Down days brought the total return for the period to 15.81%.
Volatility is common to every segment of the financial markets. Active management looks at this volatility and recognizes that if one is able to avoid a sufficient number of the down days and participate in a majority of the up moves, risk can be substantially reduced while returns benefit accordingly.
Part of the reason this tactic can be successful is the mathematics of gains and losses. A 25% loss requires a 33% gain to return to breakeven. Avoid a loss, and you have greater leverage over a buy-and-hold position to profit during market upturns.
Designing Portfolios for Disbursements
As portfolios mature and reach the point at which participants require regular disbursements, traditional investment approaches, such as Modern Portfolio Theory and asset allocation, provide insufficient protection against market declines. These approaches bet on the continuation of UP trends in the market. When down markets occur, declines tend to occur across the vast majority of asset classes.
When disbursements are required, few diversified portfolios have the staying power to wait out bear market losses. Wall & Co. strategies are designed with the objectives of limiting losses from down markets, preserving capital and providing leverage to recapture lost ground when the market resumes its uptrend.