Most investors and advisors alike may not understand or perhaps even thought about the math of losses and how market crashes and rallies affect both profits and gains.
For example, if ABC company stock is at $100 bucks a share and there are a million shares, the market value (known as market cap) is 100 million dollars ($100 x 1,000,000 shares = $100 million). If the stock drops 10% to $90 a share, the market cap of the company is now 90 million.
Extrapolating similar math to an investor portfolio and applying it to how it affects profit or gains shows just how rallies and crashes do things to a portfolio that the investor or advisor may not realize.
Using a fictional account worth $8,000.00, suppose we grow the account to $10,000.00. That means we now have $2,000.00 in profit. Now imagine the market drops by 10% and takes the stock down with it by the same 10%. Now the account is valued at $9,000.00. The profit of $2,000 is CUT IN HALF. Simply put, a 10% correction in the stock price wiped out 50% of the profit.
What this illustrates is that one’s profit is wiped out first in market crashes. Although an investor might look at a 10% market correction and on the surface may be thinking its only 10%, he may fail to realize unless he looks at his statement and also does the math, that this somewhat minor correction took a large chunk of his profits.
A larger correction of say, 20%, could wipe out ALL his profit. Not a pleasant thought, but it is a necessary one.
By doing a bit of simple math and knowing your portfolios net deposits (what you put in), and its net withdrawals (what came out in fees, commissions or personal distributions) and then having an accurate figure on what you have gained, you can be better informed on what a market rally or crash is doing to your account.
Investors who don’t perform this simple task and fail to keep a running balance may not have a handle on what the overall market movements are doing to what he has gained or lost in the portfolio. They may look at a month to month statement or even an annual statement, but few might track the total losses or gains over a long period time.
An investor should always remember what may look like a minor market correction or minimal stock price retreat, may actually be making huge dents in the profitability of the account.
Profits are the first to go in a crash and they reflect the entire downward movement of the price correction and more. Profits disappear by a multiple of a market decline, yet may increase only a proportional amount on the way up. This, in my opinion, is why minimizing losses is tantamount before looking to gains.
It is why stock declines can do far more damage than first thought because profits always disappear first in corrections. For this reason, some sort of loss prevention strategy in my opinion should always be considered.
It is said markets always come back, but prolonged and severe market crashes have in the past occasionally taken years to get back to even. Admittedly, most market routs are temporary blips in an ever increasing market, but who’s to say the next crash won’t take down the market significantly and then keep it down for years or even decades. Because no one knows whether this type of wealth obliterating market crash will occur, when it may occur, and how far it will go. To not consider some type of exit strategy is playing with fire and subsequently your life savings. Most professional traders and money managers use some sort of loss minimizing strategies for their own portfolios and the portfolios of their clients. If you or your advisor have not considered following what the pros do as it pertains to some sort of exit strategy to protect against a severe wipe out of your investments, the question becomes why not?
This article is opinion only of Marc Cuniberti, and may not represent those of this news media and should not be construed as investment advice nor represents the opinion of any bank, investment or advisory firm. Neither Money Management Radio (“Money Matters”) nor Bay Area Process receive, control, access or monitor client funds, accounts, or portfolios. Contact: (530)559-1214 or news@moneymanagementradio