How many times have you or another investor said, “It feels like it takes forever to make money and it all gets wiped out in a day” or something along those lines? We’ll watch the market go up for days and weeks at a time and be happy with our gains, but then a bad day hits and it feels like the whole bull run is gone. Well, it doesn’t just feel like our gains happen more slowly and losses faster, they actually do. The reason why is actually quite simple.
The Math Behind the Feelings
The reason our gains and losses happen so differently is basically simple math. Let’s use a $10,000 investment as an example.
On day one, 1%, what a day! Now your investment is worth $10,100.
One day two, your investment is down 1%, now your investment is worth $9,999.
Back up another 1% on day three, back up to roughly $10,099.
Back down 1% again on day four, now your investment is down to $9,988.
Even though we saw the same movement each day, your investment would be worth less than when you started.
Unfortunately for us, to see gains, we go from a smaller number to a higher number, so the 1% is worth less. When we lose money, we go from a higher number to a lower number, so the 1% is worth more.
To break it down further here are examples of gains we’d need to see in order to break even after losses:
|Lose % Incurred||Gain % to Break Even|
What this tells us is that after incurring a loss, we need to see much bigger gains to break even. On the flip side, it’s much easier to lose our gains:
|Gain % Accrued||Loss % To Break Even|
What we see here is how our gains can be erased with smaller declines. The bigger the gains, the easier it is to lose them.
What Can I Do?
Sorry, there is nothing you can do to control the stock market or math for that matter. What you can control is your own behavior when it comes to investing.
Be Patient and Don’t Panic
As the heading says, the best thing you can do is be patient and don’t panic. Remember that investing should be a long-term commitment. Getting rich overnight in the stock market isn’t the way it’s done. In a vacuum, the example above might make it seem like it’s difficult to make money in the market, but it really isn’t. Making simple and safe investments will get you where you want to be, it will just take time. By simply being patient and not panic selling, you’ll be sure to take advantage of the gains the market sees, which will outperform the losses.
Short Term Investing is Risky and Hard
When it comes to long-term investing, we know with the right investment strategy, we’ll come out on top. Short-Term investing can be much riskier and more difficult than its long-term counterpart. The losses of short-term investments are magnified by the lack of time to recoup those losses. As we’ve seen, market gains tend to happen more slowly than the losses. If your investment comes out of the gate at a loss, you’ll be racing the clock to gain it back before you need those funds. When doing any sort of short-term investing, it’s best to keep the gains as guaranteed as possible, like Certificates of Deposit and Bonds. Stocks and even most mutual funds should be avoided as they can quickly lose their value in the short term.
Cut Your Losses When Necessary
It can be difficult to admit defeat on an investment. We typically like to think that when we invest into something we’ve made the right choice. When a stock or any other investment goes down, it can be extremely difficult for it to get back up. As we’ve seen here, it’s at least a long slow process at best. Cutting your losses and re-investing the funds you still have into a new investment with more growth potential can be a better way to regain your losses on the previous investment.
Take Everything With A Grain of Salt
There are a lot of metrics we can use to measure the return on an investment. In this example I used percentages to prove a point. However, investments don’t simply move by percentage, the move by dollars and cents. Using the actual change in value of an investment could change the example a bit. If an investment goes up $100 one day then drops the same $100 tomorrow, you’re still even, no matter the percentages are.
My point here is that you’ve got to look at investments from several different angles to get a true perspective. When reading articles like this one, as I was trying to prove a point, so will others. Make sure you take in as much information as you can before making any investment decisions.
Jeff is a fan of all things finance. When he’s not out there changing the world with his blog, you can find him on a run, a Mets game, playing video games, or just playing around with his kids.