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What it takes to recoup capital after losses

Discussion in 'Investing Strategies' started by Andrew Newman, 6th Apr, 2009.

  1. Andrew Newman

    Andrew Newman Well-Known Member

    Joined:
    5th Nov, 2008
    Posts:
    175
    Location:
    Melbourne
    Hi

    I have prepared a graph that shows the % gain required to recoup capital after losses.

    For example, if your investment has lost 80%, your investment will require a 400% gain to recoup the capital loss.

    Lesson: Don't put all your eggs in one basket but have a diversified portfolio to minimise the risk of capital loss.

    The graph can be viewed at my blog:
    What it takes to recoup capital after losses - Blog - CMP Financial Planning Pty Ltd

    Kind Regards
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

    Joined:
    9th Jun, 2005
    Posts:
    4,619
    Location:
    Sydney, Australia
    Andrew - the whole argument about what it takes to recoup losses is just a quirk of the mathematical convention for how we calculate percentages.

    At the end of the day, if you buy a share for $100, and it drops by $80 ... you still need it to go up by that same $80 to recover your capital. The $80 you need to gain is no different from the $80 you lost. If the company becomes worth $100 a share again, then the share price will rise.

    Similarly with unit prices in a fund - if the unit price drops $1.60 from $2 to $0.4, then it has to make up that same $1.60 to get back to where it was.

    Yes, the mathematical convention states that we lost 80% and require a 400% gain to recover ... but in absolute terms, the numbers are exactly the same.

    Quoting statistics like this is just a FUD mechanism (Fear, Uncertainty, Doubt), used by the funds management and financial planning industry to sell product and services.

    Let me put it another way.

    You have 5 apples in a bag which you are bringing home for yourself, your partner and your three kids to eat. While you are walking home from the shops, 4 of your apples fall out of the bag.

    Do you now need 400% more apples to feed your family ... or do you need 4 apples ?
     
    Last edited: 6th Apr, 2009
  3. Andrew Newman

    Andrew Newman Well-Known Member

    Joined:
    5th Nov, 2008
    Posts:
    175
    Location:
    Melbourne
    Hi Sim

    I understand and agree with your apples example.

    With regard to say share prices, a $100 stock falling to $20 and recovering back to $100 may be a possibilty for Macquarie Bank as an example. However, some share pricies will never recover, ABC Learning as an example.

    The key for all investors is to avoid at all costs, investments that can destroy our capital to such an extent, as the investment gain you will require to recoup the capital loss is unrealistic.

    Kind Regards