How Would You React If Your Portfolio Fell By 30 Percent?
The biggest risk is not volatility, it’s the mismatch between the risk you say you can take and the risk you can actually live through.
TL;DR: Everyone knows what they’re supposed to do in a drawdown: stay invested. So why is it so hard to follow the plan when markets fall quickly? The true constraint is your hold‑through risk tolerance—how much volatility you can endure without panic selling. Portfolios should be built around this, not for how bold you feel in calm markets.
During a downturn in the market, red on the ticker tape becomes hard to ignore. Positions that have already fallen sharply begin to feel intolerable. Selling feels rational. And re-entering the market often happens only after the recovery is well underway.
We saw a version of this last April. The selloff around Liberation Day was sharp and unsettling. When markets took a leg down, the emotional response was immediate. Investors who had calmly described themselves as focused on the long term suddenly reconsidered their equity exposure. Those who reduced risk often found themselves re-entering after much of the rebound had already occurred.
The puzzle is not knowing what to do. Most investors understand that volatility is the price of admission and that staying the course is usually the correct response to a downturn.
The real question is behavioral: why is it so hard to act rationally in the moment?
After laying out why staying the course is so difficult in a drawdown, I will use the recent SaaS selloff to illustrate how hard it is to distinguish temporary repricing from real impairment. Differentiating between the two is one of the most challenging parts about long-term investing.
Why Execution Breaks Down
We know from behavioral economics that losses hurt more than equivalent gains improve our wellbeing.1 A 30 percent drop does not feel like the mirror image of a 30 percent gain.
We also tend to evaluate outcomes relative to a recent peak.2 Suppose you invested $500,000 and your portfolio grew to $1 million. Then, after Liberation Day in April 2025, the value of your portfolio drops to $700,000. You don’t feel like someone who has gained 40%. You feel like someone who has lost 30%.
These two features — loss aversion and reference dependence — explain why drawdowns feel so different from the gains that precede them. Volatility is abstract in a rising market. In a falling one, it becomes personal. Once we enter the loss domain, avoiding further losses becomes more salient than maximizing expected return.
But psychology alone does not explain the full gap between knowing what to do and actually staying the course when markets are in freefall.
Risk Tolerance Is Not Fixed
Most questionnaires measure how much risk you think you can take; what matters is what I call your hold‑through risk tolerance—how much volatility you can endure without changing course.
We often treat risk tolerance as a stable trait. Investors are labeled conservative, moderate, or aggressive, as if they are permanent characteristics.
Yet research shows that measured risk tolerance declines during downturns.3 Risk aversion rises as markets fall.
The tolerance you believe you have in calm periods may not match the tolerance you reveal when markets are falling. Preferences shift with the state of the market.
The Economic Consequence of Panic Selling
Pulling the rip cord in a downturn can have significant economic consequences.
Selling after a 30 percent drawdown feels prudent. It feels like you are protecting yourself. But sharp declines have historically been followed by stronger subsequent long-run returns, as valuations fall and the expected compensation for bearing risk rises.4
This creates an uncomfortable asymmetry. The moment you feel the need to sell the most is precisely when expected returns tend to be at their highest. Loss aversion, reference dependence, and rising risk aversion can push investors to panic sell precisely when the risk-return tradeoff is most attractive.
The right answer is simple in theory. Stay invested. But doing so is far easier said than done.
If Execution Is the Weak Link, Design Around It
If behavior under stress is the constraint, portfolios should be designed around it. A strategy that maximizes expected return but cannot be held through the inevitable drawdown is not a strategy at all.
First, equity allocations should be sized such that a 30 percent drawdown is painful but not catastrophic. Investments that trade some upside for downside protection should also be on the table (e.g., options-based volatility-smoothing ETFs and mutual funds). By reducing overall volatility, both approaches aim to increase the probability that an investor stays invested.
Another thing to consider is how often we monitor our investments. There is a large literature on “myopic loss aversion” which shows that investors who review their portfolio more frequently perceive risk as higher and allocate less to equities.5
Investors who monitor their portfolios continuously also tend to trade more frequently, and research shows that this leads, on average, to underperformance relative to those who trade less. This is in part because those who trade more often tend to react to short-term price movements rather than genuine changes in fundamentals.6
Reducing how often you check your portfolio changes the psychological experience of volatility. Fewer evaluation points mean fewer perceived losses, which in turn means less often feeling the need to reduce exposure to equities. For many long-term investors, quarterly or semiannual check‑ins are enough.
More generally, anything that increases an investor’s hold‑through risk tolerance is an improvement over cookie-cutter portfolio designs and unchecked monitoring habits.
While each of these strategies is prudent, and staying invested is usually the correct approach, an important qualification is necessary.
When Selling May Be Rational
Not every decline is an innocuous case of Mr. Market feeling depressed and offering to sell otherwise fantastic securities at a discount. Sometimes a sharp decline in the market happens in response to rational fears about a genuine deterioration in fundamentals.
In the early days of the pandemic, for example, it was entirely plausible that the global economy might remain shut down for an extended period, leading to a worldwide recession. During the Liberation Day episode, the tariffs, as announced in the Rose Garden, had the potential to disrupt global trade and tip the U.S. economy into recession.
In such moments, investors are right to reassess current valuations and their long-run cash flow projections. If fundamentals have truly deteriorated, lower prices do not imply higher expected returns. And selling may be an entirely rational response.
The difficulty lies in separating these two possibilities in real time. Is this a temporary repricing of risk, or a permanent impairment of fundamentals? Markets fall in both cases. One creates opportunity. The other justifies caution.
Distinguishing between these two possibilities while losses are mounting is exceedingly difficult.
This uncertainty has again taken center stage in the recent SaaS meltdown.
The SaaS Meltdown as a Case Study
A number of publicly-traded software firms have fallen sharply from their recent peaks in late-December 2025 or January 2026. For example, Microsoft is down roughly 17%, Adobe about 28%, Salesforce around 30%, ServiceNow nearly 40%, and LegalZoom more than 30%. In many cases, years of gains have been erased.
At this point, investors are facing a critical question: Do rapid advancements in AI represent a real threat to the SaaS business model, or is this the investment opportunity of a lifetime?
For a company like Microsoft with a wide moat, diverse revenue streams, and a rapidly growing cloud infrastructure business, this feels more like an opportunity than a crisis.
For firms like LegalZoom, on the other hand, whose value proposition may soon be replaced by AI, impairment of the business model is a real possibility.
Conclusion
We only learn whether it was a true impairment or simply a temporary repricing with hindsight. In the moment, most drawdowns feel ambiguous. Expected returns may be improving, or fundamentals may be deteriorating, or both.
Even if we knew it was the former, staying the course when prices are falling and uncertainty is greatest may be the hardest part of being a successful long‑term investor.
If you enjoyed this mildly efficient and occasionally rational take on why staying invested during a drawdown is so hard and what can be done about it, consider subscribing below. We’ll keep exploring markets and models, uncovering mildly surprising truths along the way.
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About the Author: Seth Neumuller is an Associate Professor of Economics at Wellesley College where he teaches and conducts research in macroeconomics and finance. He holds a Ph.D. in economics from UCLA. His Substack is Mildly Efficient (and Occasionally Rational) where he explores topics in finance and macro from first principles, cutting through complexity with clear, grounded analysis.
Notes and Sources
AI tools were used to edit prose; all figures are straightforward to reproduce from the cited sources.
Kahneman, D., & Tversky, A. (1979). “Prospect Theory: An Analysis of Decision under Risk.” Econometrica.
Kahneman, D., & Tversky, A. (1979). “Prospect Theory: An Analysis of Decision under Risk.” Econometrica.
Guiso, L., Sapienza, P., & Zingales, L. (2018). “Time-Varying Risk Aversion.” Journal of Financial Economics.
Campbell, J., & Shiller, R. (1988). “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies. See also Cochrane (2008), “The Dog That Did Not Bark.”
Benartzi, S., & Thaler, R. (1995). “Myopic Loss Aversion and the Equity Premium Puzzle.” Quarterly Journal of Economics. See also Thaler, R., Tversky, A., Kahneman, D., & Schwartz, A. (1997). “The Effect of Myopia and Loss Aversion on Risk Taking.” Quarterly Journal of Economics.
Barber, B., & Odean, T. (2000). “Trading Is Hazardous to Your Wealth.” Journal of Finance.