Stay Invested to Help Soften the Arithmetic of LossSheaff Briefs Editor
The stock market, it might be said, is the greatest of teachers, but attending class isn’t always fun. One of the harshest lessons the market has to impart to investors concerns the arithmetic of loss. Quite Like medical students learning about the ravages cancer can cause, investors understand the potential of portfolio losses, yet persist in hoping the lesson applies to others, never to themselves.
Fact is, as the arithmetic of loss shows, a given percentage of gain is never going to be enough to recover (return to the break-even point) from a loss of that same percentage. The chart below shows a starting portfolio of $100,000 that suffers a loss of 10%. An 11.11% gain will be required to “grow back” to the original portfolio value. To recover from a 30% loss, the portfolio would need to increase 42.86%, and so on….
Of course, the flip side of the arithmetic of loss is the arithmetic of gain. The Standard & Poor’s 500 Index hit more than 200 all-time highs in this decade alone, as Ben Carson points out in Fortune, following one of its worst ten-year periods with one of its best. (The S&P was up nine out of ten years—(2019 was the only down year with a loss of just 4.2%).
The current year has been an arithmetic lesson in itself, Sheaff Brock Managing Partner Dave Gilreath points out, modeling the greatest degree of volatility of the current decade, with the greatest number of daily moves of 1% or more since 2009.
One takeaway for students relative to volatility and the arithmetic of loss may well be the concept of remaining invested in the market at all times to avoid the risk of missing the best days. The S&P 500 annual growth rate between January 1, 1995, and September 30 of the current year, for example, was a solid 8%. Take away the best 20 days of those 25 years, and the annualized return drops to a mere 2.7%.
Were investors able to predict—and avoid—the ten or twenty worst days, the positive effects would be even more significant. Alas, as the chart below shows—and Gilreath reminds us—those best and worst days have been tightly clustered together, demonstrating all too clearly that trying to time the market is a fool’s game.
Now, with a national election approaching, investment clients are understandably risk-sensitive, reluctant to make significant portfolio decisions, yet fearful of increased volatility over the months and quarters to come.
One approach to reducing anxiety about the stock market? Gilreath suggests that, if your investments are causing you to lose sleep at night, simply reduce the amount you have invested by selling when the market is high. Otherwise, be sure to stay invested—you may have a few bad days, but the long-term results will mean you also reap the benefits of the best ones, too.
Investors ignore mathematical truths at their peril. But, staying invested and not trying to “time the market” can help soften the arithmetic of loss.