Rare Market Events Can Ruin Lives-And They Aren’t That Rare

Most people nearing retirement today can remember the 2008 Great Financial Crisis, at least if they stop and consciously think about it. However, few account for it in their investment framework for a couple of reasons.

Adjusting for demographics, many were still in the early stages of the accumulation phase at that time. While a 50 percent loss is devastating, the fewer funds you have, the lower the real-world impact. Similarly, when your portfolio is smaller, your ongoing contributions help “plug the hole” created by losses and enable a quicker recovery.

The 2008 crash was followed by unprecedented money printing and government stimulus, leading to nearly two decades of significantly above-average stock market returns, broadly speaking.

In my observation, this has produced substantial recency bias, both among investors and within much of the financial planning industry. I believe forward return expectations are too high, portfolios are too concentrated in U.S. large-cap index funds, inflation assumptions are too low, and, most importantly, the industry’s preferred measure of risk—volatility as measured by standard deviation—entirely overlooks the significant tail risk many investors carry in their portfolios today.

Bear with my “nerd math” here for a minute. It might change
your life.

When using standard deviation as a measure of risk, there’s an assumption that outcomes within two standard deviations of the mean account for roughly 95 percent of all results. In most contexts, outcomes beyond two standard deviations are statistically insignificant. That may be true when measuring something like a consumer’s likelihood of buying a new flavor of juice, but it’s far less true in financial markets.

Markets exhibit what statisticians call “fat tails,” extreme outcomes that occur far more often than a normal bell curve would predict. And these rare events can make life-altering differences.

Let’s use an example from the work of Dr. Ron Piccinini, PhD. In a 2023 paper on statistical concepts, he noted that a $1,000 investment made in 2006 in an S&P 500 ETF would have grown to approximately $4,872 by the time of his publication. However, if it had been possible to avoid just the worst 0.5 percent of trading days, that same investment would have grown to $22,559. Conversely, missing the best 0.5 percent of trading days would have resulted in an ending balance of only about $1,187.

While that example illustrates the dramatic effect both the left and right tails have on portfolio outcomes, it overlooks the work of Ryan Gorman, Shawn Keel, and Vincent Randazzo in their paper “Rethinking Risk Management and the Myth of Missing the Best Days.”

They highlight that, although the “big days” make big impacts, they tend to cluster together. In fact, eighteen of the twenty largest daily gains in the S&P 500 and nineteen of the twenty worst daily losses occurred while the index was below its 200-day moving average.

The simple conclusion from this research is that major market losses are accompanied by volatile up days. But these periods remain a net drag on both total performance and risk-adjusted returns.

If you plan to retire comfortably and on time, it’s worth reconsidering your approach to risk management so your financial life isn’t derailed by the sequence of market returns.

Article Link: https://mebfaber.com/wp-content/uploads/2025/07/rethinking-risk-management-and-myth-of-missing-the-best-days-viewright-advisors.pdf?utm_source=theideafarm.com&utm_medium=referral&utm_campaign=a-historic-dislocation

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