Image: Salvatore Vuono, freedigitalphotos.net
A big part of personal finance is how you manage your investment in shares, bonds and other financial assets.
I was talking to a friend the other day about the quirk of percentages in that they actually work assymetrically. Let me explain how this works:
If you have $100 and you lose half (50%), you now have $50. To make your money back you have to double your $50 – a 100% return. Basically you lost 50% of your investment, but have to make 100% to get your money back.
Here are some more examples:
You lose 5%, you need to make back 5.3%
You lose 10%, you have to make back 11.1%
You lose 15%, you need to make back 17.6%
You lose 25%, you need to make back 33.3%
You lose 40%, you need to make back 66.7%
You can see that the differences become quite noticeable the bigger your losses are. Strange, right?
Why is this important?
When you judge the risk of a volatile share/stock, unit trust/mutual fund or other investment you look at something called “standard deviation” – how far the value of the investment will deviate from the average value. The higher the standard deviation, the more risky the investment. The problem is, if, like our example above, your volatile stock loses 50% in one year, it is not just a matter of a 50% gain just to get back to even, you actually have to make back 100% to get back to even. Just looking at the percentages quoted in fund disclosures actually understates the risk of an investment. This is especially important when you judge results over a period which includes 2008, for example, where even Blue chip shares suffered significant percentage losses.
Always remember to take this phenomenon into account when you decide to invest in a risky investment. AJ56895V8FYE
