Sunday, February 6, 2011

How to Calculate the Arithmetic of Loss and Recovery

Did you know that during our last steep market decline from the high in October of 2007 through it’s low in March of 2009, the Standard & Poor 500 Composite Index (a broad measure of U.S. stocks) fell nearly 57%? The good news was that by the end of 2009 the index had risen almost 65% from its March low. But, do you think that after a 57% loss that a 65% gain is enough to at least get you back to your break-even point?

Let’s look at an easier example to help us figure this out: If a $1,000.00 investment loses 50%, then its value drops to $500.00. In order for the investment to return to the $1,000.00 level again, that $500.00 must do more than gain 50% - which would only bring it to $750.00. It would actually need to double! Isn’t that interesting? A 50% loss would need a 100% gain to bring you “back in the black” or back to your break-even point.

So, to answer the original question, for the S&P 500 to return to its October 2007 high, it would have to realize an increase of over 132%! How did I figure that out? By using the same loss and recovery percentages as the S&P 500 and with a nice round number like 1000, if a $1,000.00 investment loses 57%, then it drops to $430.00. So, you would need to make another $570.00 to get back to $1,000.00. All you have to do now is figure out what the percentage 570 is to 430 by using the following equation: (570/430) * 100 = 132.56%.

Here is a quick reference list to help you figure out what type of gain you would need to get back to break-even after a loss in your investment:
  • If your investment declines 10% you would need a gain of 11.1% to break even.
  • If your investment declines 20% you would need a gain of 25.0% to break even.
  • If your investment declines 30% you would need a gain of 42.9% to break even.
  • If your investment declines 40% you would need a gain of 66.7% to break even.
  • If your investment declines 50% you would need a gain of 100.0% to break even.
I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
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