The Mathematics of Losing - Investing Shortcuts

The Mathematics of Losing

By September 19, 2016Investing
The Mathematics of Losing

In the aftermath of each of the most recent bear markets, we all heard talk about how folks would need to postpone retirement to rebuild their nest eggs.

Consider the following:

An investor in their 40’s has been investing religiously for the past 20 years. Since they have many more years ahead of them, and the long-term effects of inflation will eat away at their money’s buying power, they still maintain 70% or more of their portfolio in stocks.

The market enters a bear phase and the equity portion declines by 40+%. Even with a 30% allocation to low-risk investments, the entire portfolio is now down 28-30%.

Did you know that in order for this investor to get back to even, the entire portfolio has to gain upwards of 43%, and the stock portion alone 65%+?!

It’s called the mathematics of losing and it’s one of the most insidious hidden risks of investing.

If you have $200,000 in an S+P Index Fund and the market corrects 50%, you’ll now have $100,000. True, you need to make back the $100k to get to even, but this is a 100% gain on the remaining capital, not 50%. If the market then returns to an average annual return of 9%, it would take 8 years for you to get back to $200,000.

The table below shows you the performance needed to get back to even, under various loss scenarios:

% Return Back to Breakeven


Fortunately, it is often the case that the market achieves a return greater than its historical average.

According to Mark Hulbert,

…the recovery from the recession of 2008-09, which many consider being the worst since the 1930s. By January 2013, the stock market’s inflation-and-dividend-adjusted level had risen back to where it stood at its October 2007 peak. That was just over four years after the bear market’s bottom in March 2009, and a little more than six years from the market’s pre-bear-market level. The longest recovery time since the mid-1920s was from the 1973-74 bear market: It wasn’t until December 1984 that the inflation-and-dividend-adjusted level of the stock market was back to where it stood in January 1973. But a big contributing factor to that lengthy recovery was that era’s double-digit inflation, and one could argue that inflation is unlikely in coming years to be as big a headwind for equities.

Below is Craig Israelsen’s study from 2009 that used historical market returns to calculate your odds of recovering from a portfolio loss over a specified time frame:

Probability of Recovery

Understand where your risks are, the potential impact of those risks, and strategies that may address them.

Elliot Katz

Author Elliot Katz

Elliot Katz has over 30 years of experience in the stock, options and futures markets. He has served as an options strategist and an institutional options broker. From 1989-1992, he was an instructor for The Options Institute of the CBOE. Throughout the 1990’s and early 2000’s, Elliot had roles in Senior Management at national wirehouses and private banks. Since 2007, he has worked as an independent advisor, trader, and educator.

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