Pacific Investment Advisory

How Downside Risk Affects Preservation of Principal

Many investors FORGET that when the markets head south, controlling the downside is just as important as that almighty return.

The Trouble with Losing Money

If you buy $100.00 of XYZ stock and lose 20%, you’re down to $80.

Unfortunately, if your stock goes back up the same 20%, it doesn’t return to $100, but is only worth $96.

In order to return to break even — to get back to your original $100 value — the stock must go up 25%.

The chart below shows that the bigger your loss, the larger a market move it takes to make it up.

Original Stock Cost Lose Value Regain Value To return to even
(original $10,000)

$10,000 - 20% 8,000 +20% 9,600 Takes + 25%

“ - 30% 7,000 +30% 9,100 Takes + 43%

“ - 40% 6,000 +40% 8,400 Takes + 66%

“ - 50% 5,000 +50% 7,500 Takes +100%!

We believe that managing downside risk is just as important, if not more important, than striving for total return.

The criteria utilized do not guarantee gains or profits, nor is past performance a guarantee of future gains or profits.

Effects of Volatility on Total Returns