Why Recovery Percentages Sound Scarier Than They Are
Why Recovery Percentages Sound Scarier Than They Are
You’ve probably heard it before: If your portfolio goes down by a certain percent, it takes an even higher percent positive return to get back to even. But is this actually true? Let’s explore.
Mathematically, yes; it’s true. There is no way around that. But truth doesn’t always equate to utility. In this case, this mathematical fact is completely useless knowledge to an investor. In fact, it might be worse than useless, as it can invoke fear around investing and make temporary losses seem insurmountable.
So, let’s clear the air and dive into the full story behind the numbers. We’ll use a very basic example to illustrate this.
Let’s say I own an aggressive stock in a particular industry that takes a huge hit in the market, and my stock is down 50%. I initially bought 100 shares at a price of $100 per share, for a total investment of $10,000. And now, it’s down to $50 per share, and my total investment is down to $5,000.
What will it take for my investment to get back to even? It can’t just go back up by 50%, as 50% of $50 is only $25. A 50% return will only bring the stock price back up to $75, and my total portfolio back up to $7,500; still $2,500 short of where I started.
Okay… and what does that tell us? Not really anything, except for the nature of how percentages work. Since we’re starting with a smaller amount on the way back up, the same percentage results in a lesser dollar amount. Again, this is true; and it is also useless.
Let’s look at the same scenario but through the lens of dollars rather than percentages. My investment is down to $50 per share, total value $5,000. In terms of dollar amounts, what will it take to get back to even? Exactly how much it went down by, and not a penny more. The stock needs to go back up by $50, exactly how much it went down by. My total investment needs to go back up by $5,000, exactly how much it went down by.
This is just as true as the percentage perspective, but it sounds a little less daunting, don’t you think?
I wonder how many people, upon hearing that it takes a higher percentage return after a loss just to get back to even, became more nervous and worried than they needed to be, and either stayed away from investing entirely or invested far more conservatively than they needed to. Was that in their best interest? Seems very doubtful to me.
So, next time you hear someone say that, you can nod and know they’re technically correct, but also know that the truth of that statement has everything to do with how percentages work, and nothing to do with any universal investment truth that’s actually useful or beneficial to those seeking financial independence.
Everest Wealth Advisors is a wealth advisory firm that helps individuals, families, and business’s navigate complex financial decisions through personalized, goal based planning and disciplined investment strategies.
Ryan Page, CFP®, MBA®
Office & Text:720-826-1092
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
