I don’t think most individuals really understand what happens when their investments take a hit and lose value. I was reading a great article about using protective puts and covered calls with index funds to provide for hedging and while the article was very interesting (and something I am going to look into and write about this week) there is such a simple concept found within the article that is often lost on investors. It is the concept that when you lose X% in your portfolio you are going to need X% + Y to get even.
Getting Your Investment Portfolio back to Even After Unrealized Losses
We will take an easy example found in the article,
Many clients who lose 25% one year and gain 25% the next assume they are back to even. But under this scenario, a $100,000 portfolio becomes $75,000 and only recovers to $93,750. Larger losses make things worse: A 50% loss requires a 100% gain to get back to even.
It always amazes me when I read stories of near-retirees being 70%, 80% or even 100% in equities, or almost worse, when they don’t know exactly how much risk they are taking!
The article even provides a fantastic graph showing exactly how much you need to gain after losing X% (mentions the Source as: Kingsroad Financial Insurance Services, Inc.).
As the graph indicates the larger the loss the harder it is going to be recoup your losses.
This is one of the reasons I never understood when people brag that they have all their funds in an S&P index fund. If you were unlucky enough to retire in one of those years when the market was down 5 to 20% AND you took a withdrawal it is going to be really difficult to get back to even.