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Importance of Not Losing Money When Investing
The bull market is aging and a potentially damaging trade war is ramping up. With investment risks in mind, we have written a lot recently about investing without losing money, what criteria to choose investments, safe investments for retirement, and the risks of offshore investing. A recurring theme has been the importance of not losing money when investing. One does not need to look any farther than a Warren Buffett quote to understand the importance of this subject. The Oracle of Omaha said that the first rule of investing in not to lose money and the second rule is not to forget the first rule! When the market is going up, why is it important to think about not losing money? It is all in the arithmetic.
Importance of Not Losing Money When Investing: The Arithmetic
If you have an investment that routinely appreciates at 10% a year, you should be happy. Let’s assume that this is a stock that does not pay dividends. The value per share just goes up 10% year after year. If you started with $10,000, where does that get you at the end of each year?
Exponential growth of a sound investment
Year 1: $11,000
Year 2: $12,100
Year 3: $13,310
Year 4: $14,641
Year 5: $16,105.10
Year 10: $25,937.42
This is a nice return on investment. But, what if, rather than a 10% gain every year, there are some losses thrown into the picture? What kind of rate of return do you need the next year to make up for one year losses of 10%, 20%, 30%, 40% or 50%?
Rate of return needed in one year to make up for losses in the preceding year
Loss = 10%, required return the next year = 11.11%
Loss = 20%, required return the next year = 25%
Loss = 30%, required return the next year = 42.86%
Loss = 40%, required return the next year = 66.67%
Loss = 50%, required return the next year = 100%