Now, here’s today’s article:
I saw someone post this image on LinkedIn this week.
Their comments on the image are:
You want to manage your hard-earned assets with risk management.
Here are some rough estimates of the return you need (right) to break even (regain) after taking a loss (left). Getting back to breakeven is not a one-on-one process.
Risk management is essential.
You may have seen something similar before. I know I did that. A lot of investment people talk about how small require percentage decreases big percentage gain to become equal again.
The arithmetic itself is 100% correct. But I ask, “So what? What’s the takeaway?”
Their takeaways relate to volatility and risk management. They claim that losses are “extra” harmful because they require them greater subsequent profits to come back for a moment. As this particular investor wrote:
“Returning to break-even is not a 1-to-1 process.”
In other words, “Be extra afraid of losses, because they count ‘more’ than gains.”
This is flawed logic. We need to break this line of reasoning. There’s no point.
Forgot my keys…
Imagine me walking to the office. It’s about a mile there and back. I come into view of my office building and grab my keys…oh sh**, I left my keys at home.
I call home, ask my wife to grab them for me, and she meets me halfway. But still… I have to walk 75% of the way back home to meet her. My progress dropped (-75%). I take the keys from her (~~thanks!!~~) and turn around to go to work.
How do I get there? back to where I was before? I would need more than now +300% progress to get back to office.
WOW! 300%! That’s a lot!
You might think that my walk back to the office would be ~4x harder than the walk home. After all, 300% is 4x as much as 75%. It may not seem like a ‘1-on-1 process’.
But we all know how to walk on a sidewalk. We can imagine going three-quarters of a mile back and forth. It’s the same distance in both directions! It is a 1-on-1 process, whatever the percentages say.
When a stock (or the stock market as a whole) needs to ‘return home’ along its own economic path, it can just as easily go back up. There is nothing ‘harder’ or ‘easier’ about one direction than the other.
The stocks don’t know
Shares do not know their own price.
Stocks don’t know who owns them.
Shares have no percentages.
Above all, stocks have no idea where they are right now. And investors shouldn’t worry about that either. If a company’s new earnings report justifies that it is now worth an additional $10 per share, then the new price should reflect that. It shouldn’t matter if the price goes up $10 from the old price of $50 (a jump of +20%) or $500 (a +2% jump).
Stocks and stock prices simply respond to the economic supply and demand that investors like us place on them. Supply and demand are measured dollars. Not percentages.
A decrease of $100 is equal to but opposite to an increase of $100. But measuring those two in percentages is a side issue.
If stock gains were ‘harder’ than stock losses, the question would arise: Why? What is the underlying mechanism that makes winning more difficult than losing?
(In fact, if you Real If I want to make an argument about the “difficulty” of profit vs. loss over time, I think profit seems to appear easier to achieve than to lose. But that’s not the point I want to make today.)
The stocks don’t know. Prices respond to supply and demand. Percentages up and percentages down are not ‘easy’ or ‘difficult’.
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#harder #investments #break #fall #interest