09 Jun 2023 3 min read

The equity rollercoaster

By John Southall

A volatility number may fail to convey just how turbulent a journey a pure equity strategy can be. 


Apart from the fact that a pure equity strategy is less diversified and less risk efficient than a multi-asset one in our view, the logic behind the idea that a 100% equity strategy is most appropriate for investors with long time horizons can be challenged on several fronts:

  • Time does not necessarily ‘conquer’ risk
  • Assumption uncertainty, particularly in the level of the equity risk premium, promotes caution
  • Young DC and retail investors may have equity-like ‘human capital’ (the present value of their future contributions) that encourages restraint within financial assets.

Another reason is more behavioural: well-known loss aversion. Loss aversion matters for all investors. Even younger DC investors, who cannot access their funds for decades, are vulnerable to its psychological impact. They can’t disinvest (at least not yet) but still have dangerous levers to pull if they lose faith. For example, they could switch entirely to cash or, in a worst-case scenario, stop saving.

The point of this blog is simple: a volatility number doesn’t necessarily convey how painful the equity rollercoaster can be. Everyone knows equities make for a bumpier ride, but a 15% p.a. volatility on developed-market equities may not register as that much worse than a 10% p.a. number on a diversified growth strategy. It can easily be dismissed as a small price to pay for likely better long-term outcomes, without investors fully appreciating the gut-wrenching gyrations or potentially protracted periods of disappointment involved.

To illustrate, we examine the maximum drawdown likely to be experienced by investors. The measure is intuitive – the largest observed peak-to-trough decline of an investment during a specified period, usually quoted as a percentage of the peak value. A drawdown can be sharp and brutal or a result of prolonged underperformance, disappointing investors either way.

The table below compares simulated values on pure equity versus a possible diversified growth strategy over a 40-year horizon.


According to this modelling, equity investors are more likely than not to suffer a drawdown of at least 40% over 40 years, whereas there’s only a 5% risk of this for the diversified growth investor. As another example, there is also a far-from-negligible 10% chance of a 60%+ drawdown on equity yet almost no risk of this for the diversified growth strategy.

These losses are even more harsh given the struggle to recover. A 50% drawdown, for example, requires a return of 100% just to break even. This links to the issue of volatility drag.

Those with a healthy scepticism for economic scenario generators may prefer to study history directly. The chart below shows this for the US. This paints an even more severe picture, largely because of the great depression that saw a truly horrendous 80%+ drawdown.


Aside from a brief drop around COVID-19, which saw a rapid rebound, US equities haven’t really experienced a large drawdown for 15 years. Are equity investors becoming complacent? We should also remember that this is the history of US equity, which is a significant success story! Equity sceptics often cite selection bias of the US market in studies.

As a crude approximation of how a more diversified strategy might have fared the chart below compares developed-market equity with a 60/40 equity/bond strategy[1] (this time going back to 1973). Notwithstanding that 2022 was an annus horribilis for almost all assets, the volatility buffering benefits are clear. Out of interest we also plotted Japanese equity in isolation – what stands out is its 30-year drawdown (stretching from 1990 to 2020).


There is a serious debate to be had about whether a pure equity strategy makes the most sense for long-term investors focused purely on ultimate outcomes. That aside, long-term investors should have no illusions about what a journey they’re in for by concentrating on a single high-risk factor with a modest Sharpe ratio. Over a multi-decade period there is a high chance of at least one huge drawdown. They should be confident this is something they can stick with, as this is much easier said than done.


[1] This does not have as high expected return as a fully diversified multi-asset strategy but could be similar volatility – c.2/3rds that of developed-market equity

John Southall

Head of Solutions Research

John works on financial modelling, investment strategy development and thought leadership. He also gets involved in bespoke strategy work. John used to work as a pensions consultant before joining LGIM in 2011. He has a PhD in dynamical systems and is a qualified actuary.

John Southall