This is an homage to number 91 in your program, the captain of your Toronto Maple Leafs – John Tavares. It’s about a quick and dirty calculation hack you might find useful then thinking about market gyrations. Big moves and market volatility can be killers to your portfolio value. Even if you think you’re getting back to where you started.
Let’s just use 30% as an example. What happens to your wealth if there’s a 30% move in one direction followed immediately by a 30% move in the other? The answer is that either way, you’d be down 9%. Anyone who starts at 100 would end up at 91. Here we go: Start at 100. Let’s call it $1,000,000. If your portfolio drops by 30%, you’d be down to $700,000. From there, if you go up by 30%, you’d add $210,000 and get up to $910,000. A 9% drop. Number 91 in your program.
It works in the opposite direction, too. Start at $1,000,000 and go up 30% to $1,300,000. From there, drop 30%, which is $390,000. For those of you following along at home, $1,300,000 minus $390,000 is…. $910,000. That’s number 91 in your program.
The calculation works at all dollar amounts. The way to remember it is embarrassingly simple, too. Take the percentage change (multiples of 10 are easiest), drop it to 1/10 of that amount and square that number. So that we’re all on the same page:
- Changes of 10% (both directions) is a net drop of 1% (1 squared is 1)
- Changes of 20% (both directions) is a net drop of 4% (2 squared is 4)
- Changes of 30% (both directions) is a net drop of 9% (3 squared is 9)
- Changes of 40% (both directions) is a net drop of 16% (4 squared is 16)
… and so on. The lesson here is to avoid big volatility, because the bigger the volatility, the bigger the overall drop… even if the notional quantum of the moves is identical. The hack works in both directions – whether you start with a rise or a drop, you end up in the same place at the end. When I started in the business, there was a mutual fund manager who promoted his offering by using the phrase “win by not losing”. That stuck with me. My sense now is that we need to proceed with extreme caution. If we can do that, we can all win, provided we don’t incur major losses along the way.