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On Recovering from Investment Losses

Investment

Many investors assume that if they suffer portfolio losses of 20%, for example, all they have to do is earn 20% to get back to break-even. Not so, because after the loss their portfolio is starting from a lower point. So it's a real eye-opener to learn....

If I lose.......to recover, I must earn

      -10.0%                    11.1%

      -20.0%                    25.0%

      -30.0%                    42.9%

      -40.0%                    66.7%

      -50.0%                  100.0%

The S&P500 stock index hit its peak in October 2007. From there, it lost roughly 57% of its value (excluding dividends) into March 2009. So how much gain is necessary to get back to its peak? Try a little over 132% (excluding dividends). As I write, full recovery is still quite a ways off.

Traditional wealth advice recommends that you diversify your portfolio among various asset classes based on your time frame and objectives. Usually this involves various types of stocks, bonds, and maybe some cash. Then you passively ride these investments up and down, tossed about by whichever way the market winds blow. Think back to 2008, when most such “diversified” investments headed south around the same time. Lots of fun, right?

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Rule #1: Never lose money. Rule #2: Never forget Rule #1. -- Warren Buffett

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A wiser approach—especially in long-term bear markets like this one—may be to reduce exposure to overpriced markets and investments, and attempt to sidestep the likely “train wrecks.” Buy good traditional and alternative investments when they appear to be a bargain and can be had at relatively safe prices. This assumes a more active and engaged approach to managing your portfolio than traditional buy-and-hold advice. 

Of course, it's impossible to precisely and consistently time the markets. But who said that you have to?

The investment game is won not by precision---only picking winners at the right time or avoiding all loss---but by avoiding catastrophic losses and then seeking modest gains. When you manage the downside, the upside will often take care of itself. Plus you don’t then need to knock one out of the ballpark just to get back to break-even.