Investing

Understanding a middle school math concept can make you a better investor: This example shows how

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Key Points
  • High-percentage drops in your investments require an even large gain to break even.
  • Experts note that you an drive higher returns over the long term if your portfolio loses less than the market when stock prices slide.

OK, so your math teacher may have been wrong about a few things. You do, in fact, "carry a calculator around in your pocket every day," despite what you were told. But that doesn't mean the middle school version of you was right to question if you were ever going to have to use this stuff when your class was going over percentages.

Say you're invested in an S&P 500 index fund, and you read in the news that the index fell 1% on a particular day. Then the next day, it rose 1%. Are you back to breakeven?

If you remember the formula for percent change you may have learned in 8th grade, you know the answer is no. If weren't sure about that one, maybe it's time for a refresher. Because understanding percent change is key to understanding how investments behave and how your portfolio will grow over time.

Calculate percent change to understand how investments move

If you're listening to the news in your car you may hear a market update that expresses market movement in terms of points. Something like: "In market news, the Dow fell 363 points today, and the Nasdaq shed 250."

If you tend to find that news less than useful, you're not alone. Ask someone to name how many points the Dow is at, and chances are they won't know the correct answer of "about 33,000" off the top of their head. (The Nasdaq is at about 13,000 these days, by the way.)

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Instead of using points, many financial media outlets tend to describe movements in indexes the same way you'd see gains or losses in the investments in your portfolio — as a percentage. To find percentage change, you subtract your starting value from the final value, divide by the initial value, and then multiply by 100.

So if the Dow started the day at 33,000 and closed at 32,670, you'd subtract to get -300, divide by 33,000 to get 0.01, and finally multiply by 100 to arrive at a 1% decline.

Understanding percent change in your portfolio

Back to the original question. If the total value of your investment is $100 and it declines by 1%, it's now worth $99. Add 1% from there, and you're up $99.99.

That may not seem like a big deal at first blush, but the bigger the numbers, the more stark the disparity becomes. Say you invest $100 in a stock that declines by 50%. Now it's worth $50. To get back to breakeven, your investment now needs to double in value — a gain of 100%.

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Large downdrafts can have an outsize impact on your portfolio, as they require your investments to deliver extra-high performance on the upside to climb out of the hole. That's why investing experts recommend taking steps to tamp down on your portfolio's volatility by diversifying among a variety of investment asset classes. Doing so not only gives you a smoother ride, but can also help your performance over the long run.

To illustrate this, investment research firm Seagall Bryant & Hamill analyzed the performance of the broad-market Russell 3000 index over the 20 years ended in September 2020. Over that period, analysts found that a theoretical investment that performed 90% as well as the index when it was going up, but sank only 75% as much when stocks were falling, handily outperformed the index.

There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.

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