It was either agony or ecstasy for football fans, but last week’s Super Bowl stunner was a teachable moment for 401k participants about saving and investing, especially with concept of “winning by not losing.” It’s something 401k advisors should share.
Given Atlanta’s Matt Ryan had never lost a Super Bowl (emphasis on “had”), it seemed clear from the numbers it meant a better career than Tom Brady, who had lost not one, but two, Super Bowls.
As a Boston College alum along with Ryan, I really wanted to enjoy the alternative facts contained in the following popular tweet, though the inference was probably flawed:
“Matt Ryan’s career better than Brady? Hard to argue the stats …
Ryan: Zero Super Bowl Losses
Brady: Two Super Bowl Losses
If only it were that simple, but it’s easy to see how numbers are manipulated. Unfortunately for 401k participants and investors in general (as well as Ryan), the reality is often quite different, especially when it comes to the absolutely devastating math of a big loss, as the following percentages illustrate.
Percent of Capital Lost Percent Gain Needed to Earn Back Loss
10 percent 11 percent
20 percent 25 percent
30 percent 43 percent
40 percent 67 percent
50 percent 100 percent
60 percent 150 percent
70 percent 233 percent
80 percent 400 percent
90 percent 900 percent
The sheer number of downturns that equity markets have experienced over the last 40 years make these numbers particularly frightening. After experiencing a 50 percent loss, an investor needs to earn 100 percent just to break even.
For an even more extreme, real-world example, consider that the Nasdaq Composite Index lost 78 percent from its March 10, 2000 high through its October 9, 2002 low. It means an investor in this index needed almost 400 percent (or five times their remaining capital) to get back to even.
It took the index more than 12 years from its bottom to once again reach its high. Most investors don’t have the patience or the time to suffer many large losses; thus the importance of them to manageable levels.
Diversification is key; the only real free lunch in finance. It is possible to combine investments with positive expected return and relatively high volatility on their own in a way that minimizes portfolio volatility without degrading returns.
The crucial task for 401k participants, and their advisors, is to find investments that have low or negative correlation to each other, i.e., when some investments are doing poorly your other investments may be doing well, thereby smoothing out portfolio returns. When one does this properly they are well on their way avoiding large losses, minimizing volatility and thus “winning by not losing.”
Jeremy Frank, FRM, is Director of Quantitative Research and a member of the portfolio management team at Denver-based 361 Capital.