The objective of risk control is to limit the deep and prolonged losses that each asset class periodically and inevitably suffers during the economic cycle (sometimes greater than -50%).
This is very important both for psychological/behavioral and compound reasons:
- Psychologically: For a given % change in your equity, losses are much more painful than gains (chart on the right). This asymmetry in the perception of returns dispersion is one of the main reasons why an investment plan or strategy is abandoned prematurely. Due to this universal investor feeling and consequent behavior, keeping volatility and drawdowns low (through diversification and risk control as the Austrian Strategy does) is key in orther to be able to follow and achieve the objectives of a long-term investment plan.
- Increasing the compound effect over time: Low drawdowns and low volatility allows, for a given rate of return, to produce greater gains over the long term and to recover in a shorter time. An example with two investors A and B:
