Yesterday’s trashing in the stock market offers us a chance to review the arithmetic of losses and the value in a counterbalanced strategy.
Technology shares as represented by the Nasdaq composite index lost 3.8% on the day.
Let’s say, for example you began the day with $10,000 in Nasdaq. By late afternoon, when the market closed, it was worth $9,620 or down 3.8%. You now need (not a good word in investing) a gain of 4% to get back to even.
Now, imagine a string of ten days like yesterday, or a 38% decline. A 61% gain is needed just to get back to even, or where you began with $10,000.
Think it can’t happen? So far this century Nasdaq has had annual declines of 38% or more t-w-i-c-e.
Now, imagine you also began the day with $10,000 in GNMA bonds. Let’s use Vanguard GNMA as an example which gained 0.2% making your position worth $10,020.
This century, in the two years Nasdaq declined by at least 38%, Vanguard GNMA made at least 7 percent per year.
OK, so perhaps a balanced approach makes sense in putting the arithmetic of losses in your favor.
Let’s combine the two $10,000 positions, one in Nasdaq and the other in Vanguard GNMA and see how they complement each other.
Your holdings began the day at $20,000 and ended the day at $19,640 or a 1.8 percent loss meaning a 1.8 percent gain is needed to get back to $20,000. Imagine a string of ten days like yesterday or an 18% decline. A more manageable gain of 22% is needed to get back to even or about a third of the work if everything was in Nasdaq.
Understand the arithmetic of losses with the wisdom of a counterbalanced attack and you’ll look at days like yesterday as just another day in the market.
Arithmetic of Portfolio Losses Counterbalanced Total Returns
