Understanding the Math of Recovering From Losses

Everyone knows the stock market has its ups and downs, but just what’s involved in recovering from a serious down? If you lose 10% one year, but your portfolio returns 10% the next year, are you even again?

The short answer: no. The math of recovering from a loss isn’t quite that symmetrical. You have to gain more than you lost to recoup all your losses. To understand why, let’s look at a hypothetical example. Say you have a $50,000 portfolio. In Year 1, you suffer a 10% loss and are down $5,000. That leaves your portfolio worth only $45,000.

In Year 2, the market rebounds and your portfolio rises by 10%. However, that 10% increase is based on a $45,000 portfolio, not $50,000. That means the 10% return adds only $4,500 to your portfolio, not $5,000. You are still $500 down from where you started. You would actually have to earn a return of a little over 11% to get back to your original $50,000.

The bigger the loss, the bigger that rebound needs to be to get you even. For example, if that $50,000 portfolio had taken a 40% hit, as many did in 2008, you’d need almost a 67% increase to offset that $20,000 loss. That could take several years even if stocks perform well to get back to the original $50,000.

The challenge is compounded by investor psychology. Adjusting your asset allocation to aim for a higher return is one way to try to recoup losses faster. However, many investors find it difficult to take on additional risk after having watched their investments take a hit. And there’s no guarantee that more risk will necessarily produce the desired result—at least not within the desired timeframe.

The lopsided nature of recovery from market losses underscores why risk management is such a key component of successful portfolio management. Being realistic about the risk level your portfolio involves and how much time you have to recover from potential downturns should help increase both your emotional and financial resilience.

At Henssler Financial we believe you should Live Ready, which means understanding the risk in your portfolio and what it takes to recover from a loss.  If you have questions regarding your portfolio, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.

Disclosures

The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.