The outcome of this mathematical relationship is that even if an investment falls by 5% and subsequently rebounds by 5%, it ends with a loss of 0.25%.
Given its impact on the long-term growth of wealth and potential ramifications on behavioral elements, investors should be mindful of portfolio or investment volatility and downside resilience measures, not just returns data. They may find that downside resilience isn’t just nice to have — it’s practically a must-have for long-term wealth creation.
When comparing investment alternatives, consider a few important metrics beyond absolute results:
- Risk-adjusted returns, which typically incorporate both the performance achieved and the volatility experienced over a given time period. High Sharpe ratios* relative to comparable peers signify that an investment delivered attractive returns given its level of risk.
- Up- and downside capture ratios can be useful tools to help assess how an investment has performed in up and down markets. Specifically, the upside capture ratio is a measure of how well a portfolio performed when its index had positive returns, while the downside capture ratio indicates how it performed in periods of negative market returns. Generally, higher upside capture and lower downside capture is preferable.
- Wealth generated in dollars — What’s most important for participants is how the metrics above translate to wealth creation in dollar terms. Tracking the growth of a hypothetical $100,000 investment over a long time frame helps illustrate how a given investment approach may deliver spendable wealth.
In the paper linked below, we take a closer look at how the thoughtful approach to risk mitigation taken in the American Funds Target Date Retirement Series® has delivered favorable outcomes for participants.