Why losses are so costly to a fund

by | Feb 3, 2017

 

In past articles and videos I’ve often stated that:  “Losses are more costly to a fund than gains are beneficial.”  I recently had a member ask me exactly what that means.  Let me illustrate with a simple math problem:

If you start with 10,000$ and make 50% on your money this year, then lose 50% next year, are you back to even?  Up 50% then down 50%, must be a wash right?

10,000$  *  1.5  =  15,000$   —>   15,000$  *  0.5  =  7,500$

 

But actually you’d be down 25%, and it’s the same answer if you lose 50% the first year and then make 50% the next:

10,000$  *  0.5  =  5,000$   —>   5,000$  *  1.5  =  7,500$

 

This is how investment returns work.  Because it’s a geometric calculation, losing months cost you more than winning months help you. It’s extremely important for people who want to maximize their performance in the long-run to do everything possible to eliminate the drawdowns and negative months.  Let’s stretch this example out 20 years:

 

Trader 1:  Makes 10% every year for 20 years:

 

Trader 2:  Makes an arithmetic average of 10% per year, but with some losing years mixed in:

 

Trader 3:  Makes an arithmetic average of 10% per year, but with some major drawdowns added in:

 

Consistency over time and reducing drawdowns is rewarded far more than risk taking because as we know:

Losses are more costly to a fund than gains are beneficial 

 

At Volatility Trading Strategies we focus on risk management and achieving consistent returns over time.  We never take excessive risks.  We never chase unrealistic returns.  Investing is not a sprint, it’s a marathon, and the most consistent traders are the ones that make it to the finish line in the best shape.

 

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