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.