The Value of Money and How a 30% Loss Requires a 42.9% Gain to Get Even

When I was much younger and still in high school, I had a part-time job at the local grocery store. My family was not wealthy and, as a teenager, if I wanted to have money to go to the movies or to the local Dairy Queen (the only fast-food restaurant at the time in my community), I had to go work and make the money myself.

I learned this early on, and I remember being very young (under 10 years old) and collecting bottles out of the ditches to exchange for money. Or asking my grandfather if he needed his lawn mowed, after which I was paid 25 cents. At the time, 25 cents bought me 25 pieces of one-cent candy at the local Red and White store: the only grocery store and butcher shop in the community.

I have been aware of the real value of money since my childhood. Aware of what it takes to make money and save money, what that money can buy and the necessity to have money to get the things I needed/wanted at a future time.

I got my first bicycle at the age of 13, for my birthday. It wasn’t new. My father had found it and fixed it up, painted it and gave it to me for my birthday present. To me, it didn’t matter that it wasn’t new. I now had a bicycle and could ride with my friends who all had had their own bicycles for some time already. But I was then 13 years old and didn’t know how to ride a bicycle, because I never had one to learn on. The choice was now mine, if I wanted to ride with my friends. So, I got on it and, after several spills and scratches, I got the hang of it, and I was mobile.

A few years later, when I was 15, I got a job at the grocery store and began saving my money. Soon, I had saved enough money to buy a new bicycle – a “CCM 10 Speed” bicycle – from the local sporting goods store in the neighbouring town. I was so excited. It was bright white with 10 gears, versus the one gear on my old bike. The concept of money – what I had to do to earn it and what I had to do with it afterward to fulfill my spending plans – was fully entrenched in my mind.

It was 1976 and I had a job and a new bicycle – which is how I got to and from my job – and was earning more money that I saved, so I could have what I needed to buy something else in the future.

I learned how hard it was to make money in order to get the things I needed. There were no credit cards and no money from my parents for whenever I wanted something. If I wanted it, I had to work, save and pay for it.

This was a life lesson that most of my generation learned, following the generation that lived through the Great Depression of the 1930s.

The reason I am telling this story is because when one has worked and saved money to use for a specific future purpose, they typically want to keep it and not lose what they have accumulated. The savings have a purpose, and that purpose is the important part of why this process happened in the first place.

Which brings me to today and the profession I’ve been in for nearly 40 years now.

I am entrusted with and invest other people’s money.

Monies that my clients have accumulated over their lifetimes that they now have invested for a specific purpose, which I am entrusted to administer.

Over 40 years of practising this art of investing, I have observed that most people want to invest money they have saved/accumulated to make more money from it, with the condition that they don’t lose it in the process.

Fair enough, as that is what one should desire and why the financial services industry evolved and exists.

Now, this is where we need to discuss what I refer to as “realistic expectations.”

When investing money, there are three basic, fundamental principles one needs to understand and follow.

The first is “the objective” one wishes to achieve from the investment of the money. The second is “the level of risk” one is willing to accept from the investment choices made to achieve the “objective.” Thirdly, the timeline this money can be invested for, to achieve the objective.

Investment objectives outlined by investment service providers typically fall under three categories:

Income: The purpose of the investment is to generate an income stream the investor can collect and use to spend.

Growth: The purpose of the investment is to have growth in the capital value of the investment over a long timeline, with less focus on generating income.

Speculative Trading: The purpose of the investment is to trade investments made over a shorter period of time, based on specific entry and exit points to generate short-term capital gains on the investment, with no focus on income generation.

An investor can have one or more of these objectives, by allocating specific amounts of money to each and structuring their holdings to achieve a specific outcome.

Risk tolerances outlined by investment service providers typically fall under three categories:

Low: The investor cannot tolerate any risk or can tolerate only a small decline in the value of the invested monies over the investment period. These types of investments are mostly short-term bonds and guaranteed bank term deposits.

Medium: The investor can tolerate a moderate amount of change (decline and appreciation) in the value of their investments.

High: The investor can tolerate a high degree of fluctuation in the value of their investments.

None of this is a perfect science, as there are times when all investments, aside from guaranteed bank term deposits, can deviate from the expected risk levels of the category chosen.

For example, one may feel that a medium risk tolerance is suitable for their needs, based on their personal circumstances and the timeline. However, there are times when the level of decline in the value of the investments exceeds those expectations.

That’s why, at the start of our relationship with our clients, we ask questions like this: “How much of a decline in dollar terms can you tolerate on your investments at any given time?”

The industry questionnaires and risk tolerance guidelines mostly ask such questions and present the results in “percentage terms,” which I find inadequate to help my clients understand what I’m asking to determine what to do for them.

Personally, I like to discuss investing and risks of specific investment positions in dollar terms, not percentage terms.

For example, one does a risk tolerance questionnaire and the result says a person could have a 30% tolerance for declines in the value of their portfolio in any given one-year period. My feeling is that this result doesn’t show the client the full magnitude of what a 30% decline of their life savings means.

Personally, I like to talk in dollar terms. For example, if the questionnaire says a client can tolerate a 30% decline in their investments, that can mean different things to different people.

If a person has $10,000 invested and it declines 30%, they have $3,000 less than what they originally invested. This is likely not a life-changing event for them. But if a person has $1,000,000 invested and it declines 30%, they have $300,000 less than what they had invested. I expect this person could have a different feeling about the situation.

Regardless of what any risk questionnaire says, my personal view is that most investors will not view the decline in the “dollar value” of their account the same way, compared to when it is presented in “percentage terms.”

So, it is very important for any investor to understand investment objectives and investment risk.

The objectives are relatively straight-forward and specifically related to what the investor needs or wants their investments to do for them.

The risks are what people need to understand fully, including the fact that the risk they choose affects the returns they can expect on their investments and the degree of fluctuations they will need to tolerate on those investments. Risk ratings do not mean you will lose your money. They reflect the type of investment you hold and the degree to which it can fluctuate in value. Low risk means it will fluctuate a little. Medium risk signifies it can fluctuate moderately and high risk means it can fluctuate a lot. Understanding what high risk truly means is essential—it doesn’t necessarily imply losing all your invested capital, but is linked to the nature of what you own, not just how much its value may fluctuate.

Example: If you hold a position in gold, silver, platinum or any commodity bullion trust, it will be classified as high risk because it is a commodity. It doesn’t mean you will lose 100% of your investment. It just means the value of that position could fluctuate up or down much more than other holdings. So, one needs to understand what these risk categories mean in relation to what one owns personally.

Why does all the above need to be understood today?

Because we are at an extreme point when it comes to investing risks. I have been talking about this for some time and yes, things just keep going on. There are many reasons for this, with the simplest explanation being: stock markets can stay irrational longer than one can stay solvent. We are in an environment of investor complacency. There has not been a sizable stock market correction where market valuations revert to more realistic valuations since the 2007-2009 bear market caused by the Great Financial Crisis, when we had the last 50% + market decline. Before that, it was the 2000-2003 bear market with another 50% + market decline caused by the unwinding of the Tech Bubble, where many technology stocks declined by 80% or more, with some becoming worthless.

For the major North American stock markets, that’s 16 years of market gains since the last bottom in 2009, with no significant correction, and now, we have the most overvalued stock markets in recorded history. More overvalued than 2007, more overvalued than 2000 and more overvalued than the 1929 market crash that led to the Great Depression.

Stock markets, real estate values and other assets are at historical extremes, and one needs to be aware of these things to manage the potential risks and how it relates to one’s current capital investments.

I am not averse to investing in anything, as long as it is suitable. I am willing to accept the risk, if I can see the value and the technical trends support a case for buying. However, I am not going to be reckless and invest my money into asset classes that are at extreme valuations and have the potential for large declines at some point.

I’m not suggesting that a significant decline in any stock market is imminent. What I am saying is that major market events have occurred repeatedly throughout history—often when few expect them.

I look for investments that offer the potential for positive returns as well as manage the risk I must accept regarding any declines in the value of my positioning.

I have a very different style and view on investing that evolved over 40 years of lessons in this business, which formed the mindset my team and I now bring when dealing with other people’s money.

Yes, if you own anything other than a guaranteed bank deposit, it will fluctuate in value. Determine what that dollar amount is for you, discuss that with us on a regular basis by updating us on any changes in your views or personal circumstances, and we can adjust accordingly, if necessary.

Remember how the simple math of market declines and gains work.

If your investment(s) declines 30% in value, it requires a 42.9% gain to get back to even.

This is something many need to understand. If an investment drops 30%, it doesn’t just need to rise 30% to break even. It needs to go beyond that point.

The larger the percentage number of the decline, the larger the percentage number the position needs to gain to recover.

For example: the 50% stock market declines of 2000-2003 and 2007-2009 were very painful for all investors. On top of that, the math is that if you lost 50%, you had to make 100% returns after that loss to get back to even.

Here’s another fact for you. If one had $1 invested in the S&P 500 index in January 2000, you had to wait the next 13 years to get your $1 back.

I understand how hard it is to make and save money. I know how long it takes to save and accumulate the money one needs to invest and save for their retirement years. I am also very mindful of how a large decline in our investments could affect our future. There is a point in our lives where we just don’t have enough number of years left to recoup the declines in our investments. By taking all these things into account, one should understand and properly structure the investment plan that is most suitable for themselves.

As anyone dealing with us knows, if you are invested in our proprietary models, you own what I own personally. It’s the only way I can advise my clients on what I believe they should own. We spend a lot of time doing our own research to determine what we feel is the most suitable positions for our strategies, with the “I (Stephen) have skin in the game” approach.

In our models, if you own it, I own it.

Thanks for reading.
Stephen B. Bishop