Minimizing large investment losses such as those experienced by many during the past two years can be a more important factor in one's financial health than large investment gains.
Vanguard Founder John Bogle frequently discusses the importance of avoiding large losses:
“People often don’t understand why they are still in a deep hole, even after they’ve had a year of great returns,” said John Bogle, the founder of Vanguard and the creator of the first index mutual fund. It is because when your portfolio shrinks substantially, you need an enormous gain, in percentage terms, to climb back to where you started. This is part of what Mr. Bogle (citing Justice Louis Brandeis) calls “the relentless rules of humble arithmetic.”
A recent New York Times article discusses a situation in which an investor loses 40% during a given year.
If that terrible year is followed by a spectacular year in which the investor experiences a gain of 40%, the person would still have a 16% loss relative to their starting position.
This investing arithmetic is especially brutal when it plays into sequence of returns risk and impacts investors who are recently retired or near retirement.
Source: New York Times
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