muses of the moment

April 11, 2013

The deception of percentages

Filed under: DOW and S&P500, Financial Talking Heads, Inflation, Long term investing, Odds 'n ends, Stock Market — totallygroovygirlfriday @ 1:34 am

groovygirl often talks about percentages. Such as don’t worry about the dollar amount of the investment allocation, but the percentage. Most people look at their 401k statement or broker statement and see if their actual dollars have gone down or up from the last statement. This is a good bird’s eye view and something everyone can relate to.

However, there is another key investment lesson about percentages to be aware of. It is something that talking financial TV heads use.

Let’s say a stock or stock index has gone down 30% over a year’s time. Let’s say you own $100 of that index. And let’s say you sell at the end of the year and your dollar loss is $30, 30% of $100. The stock is now at $70. You decide to buy the next year at $70. And during the next year the stock has a 30% gain. You sell and take your gain, which is 30% or $21. The stock is now at $91.

If you look at percentages, 30% down and then 30% up over a 2-year period, you may be fooled at first glance that you have gained back your losses. But you have not, you have lost $9 or almost 10% of your original $100 investment. We all listen to stock market percentages of gains and losses and so keep in mind this phenomenon.

Side musing: this happens all the time. The summary at the end of the news cast is DOW is down 3% today and then the next day it is up 3%. That is an actual loss, not a break-even, over a 2-day period. Train your mind to know that is a loss.

Try the math on the opposite scenario: you gain 30% on a $100 investment, but lose 30% right after that? Is it an over-all gain or loss? How much?

What about a 30% gain one day and another 30% gain the next? Is the gain 60%? Nope, what is it? And what about a loss of 30% one day and another loss 30% the next, is the loss 60% of the original investment, nope….

Hint: only one scenario yields a gain to the original investment, all others are losses to some extent. Even though the percentage up and down stays the same.

On a deeper level, depending on tax rates on the investment for the loss year or the gain year, you may be losing more money (or gaining, but doesn’t seem to be heading in that direction). Depending on the purchasing power or value of the under-lying currency, you may find that the gain or loss would buy you more or less than at the beginning of the investment.

Many things to consider when investing, and even more importantly, when to sell.

Advertisements

3 Comments »

  1. I agree, percentage changes can be very deceptive. If I buy a stock and it goes down 50%, it has to go up 100% from there for me to break even. If the stock goes down 90%, it has to go up 900% from there for me to break even.

    By the way, is this the same mania and blow off we can expect for gold and silver one day?

    “Bitcoin crashes over 50% just one day after bold public prediction by Mike Adams of Natural News”
    http://www.naturalnews.com/039865_bitcoin_crash_prediction_Mike_Adams.html

    Comment by sw — April 11, 2013 @ 11:04 am

  2. groovygirl thinks gold could do some sort of blow off like that in the future. That is how bubbles work.

    gg

    Comment by totallygroovygirlfriday — April 11, 2013 @ 11:21 am

  3. In case you missed it, Zero Hedge has a great post on visualizing the “real” value of everything. It’s what you’ve been teaching us for several years now. Thanks again!

    http://www.zerohedge.com/news/2013-04-10/visualizing-real-value-everything

    Comment by sw — April 11, 2013 @ 11:49 am


RSS feed for comments on this post. TrackBack URI

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Blog at WordPress.com.

%d bloggers like this: