VIDEO: Retirement Investing Pitfall #9 – The Unbalanced Loss Effect

 

 

This video is going to cover yet another retirement investing pitfall which is referred to as The Unbalanced Loss Effect. So, let’s say you buy a stock for $100 a share, and the stock declines in value to $70 per share. You have suffered a 30% loss in the value of the stock. Now ask yourself, how much would the stock have to rise in value for you to get back to breakeven? I know that 30% might seem like the obvious answer, but that is in fact, incorrect. Think about it…30% of $70 is $21, meaning that if the stock rises 30% after falling 30%, its value will be $91, which is $9 short of the breakeven point of $100. The fact is, the stock must actually rise about 43% to get back to $100 ($70 times 43% equals $30). This is what’s known as the unbalanced loss effect. Investors who don’t understand this effect are often prone to taking larger risks, with bigger portions of their investments, simply because they don’t fully realize the devastating impact these steep losses can have on their portfolio’s performance. And if these loses happen later in life, they can really set you back in your retirement planning. I feel it’s so important the scale back risk as we get older because huge losses are hard to come back from. Understanding pitfalls like the unbalanced loss effect, and how we need bigger gains on a percentage basis, than our loss, to get back to even. This can ultimately help make sure we better manage our investment risk throughout retirement.