Negative Investment Returns

Albert Einstein called compound interest “the greatest mathematical discovery of all time.” We’re all aware of how compounded interest can work to your advantage over time, but the opposite holds true, even more so.

Negative returns are deadly to an investor in two ways. You lose both money and time.

If you have an investment that loses 5%, you figure you have to earn 5% to get back to even, right? Wrong. You need to earn 5.26%.

Lost 10%. You need to earn back 11.11%.

Down 25%? You’ll need to make 33.33% to get even.

Down 60%? You sure you want to know? You’ll need to make 150% on your investments! Just to get back to where you started.

It gets worse. When you have a negative investment return, you also have to earn back the purchasing power of your money, i.e. inflation. So that 10% you lost last year? If you intend to make that back this upcoming year you’ll need to earn 11.11%, plus 3.9% for inflation, plus 0.60% or so for investing costs. That’s 15.61%. If you invest in stocks, split 50/50 between NASDAQ and NYSE Composite indexes, you can expect a return of 9.05% per year, based on a 50 year average. So it should take 1.72 years to get back to even, right? (15.61%/9.05%)
Wrong. Remember the inflation cost and the investing costs are per annum. So factoring in inflation under this scenario, it will take nearly 2 years to get back to where you started. 2 years to compensate for a lousy 10% loss.

That’s also 2 years of time you lost. If you had simply left you money in T-Bills, where you are guaranteed a positive return, you would be about 7 percentage points ahead! We only have so many years in which to invest, so it is imperative to make the best use of time.
Assume you start saving at age 25, and continue to invest until you are 65. That’s a 40 year investing life you have. In the scenario above, a 10% loss cost you 2 years out of that investing life, i.e. 5% of the entire time you have to invest. Also gone is 2 years of positive compounding.

Assume you are 50 and plan to invest for another 15 years. Losing 2 years out of those 15 takes away 13% of your remaining investing life.

You have served 2 years in investment jail for a measly 10% loss! I’ll be gentle and not calculate the effect of a 25% loss.