Earlier this year I swore off gambling in the stock market, vowing to keep my investments just that, investments. Well the investment club I am involved still has an appetite for it. I actually don’t mind because this provides me with some exposure to that world without risking “my” money (yes, some of it is my money but eight-ninths of it is not). A recent decline in one of these types of equities occurred almost contemporaneously with me finishing Benjamin Graham’s Intelligent Investor reminded me of a topic I haven’t thought about in a while, how much gain is needed after a substantial decline in a stock’s price.
What is the Cost of a Substantial Loss?
The idea is simple, if you have an investment that loses 50% of its value, how much does it have to increase in price to get you back to even? Most people would instinctively respond 50%…and those people would be wrong. If a stock loses 50% of its value it needs to gain 100% to get you back to even. For example, if you own ABC, Inc. at $100 a share and it suddenly drops to $50 a share you lost 50% of your initial investment, however, to get back from $50 to $100 your current investment needs to double.
Investopedia provides a fantastic chart:
|Percentage Loss||Percent Rise To Breakeven|
Understanding these numbers allow you to look at the equity in a different way. You can start asking yourself questions like:
- Is Mr. Market nuts or is this a value trap? This stock shouldn’t have lost 10% I should buy more, more, more!
- Nothing has changed so maybe I should just hold on since I am investing for the long term?
- The volume has dropped along with the price, has the big money moved elsewhere? How long is it going to take to get back to even?
- Did the company release news recently? Maybe I should do more research