Good morning. We usually only post a new blog on govloop.com on Monday’s, but I thought this commentary might be of interest to some of you. We will discuss account returns, how they are calculated, and why your account may not have rebounded as much as you might have expected after last week’s big rally….
Stocks were hit hard once again yesterday, giving back much of the gains made during the Thanksgiving week rally. I hope this scenario is now etched in your mind – holiday trading on light volume can reverse very quickly after the holiday.
Last Tuesday we said:
“This market is not out of the woods yet by any means, but the powers that be are going to milk this Citi bailout for as much upside as they can get, probably before the selling kicks in again. I don’t think there is any doubt that this market will have to face more problems in the future, but if you ran a large money management firm and you wanted/needed to sell some of your questionable stock holdings, wouldn’t you want to prop them up to look more attractive before you sold?”
Doesn’t that seem to be what happened here? Was there anything new on Monday morning that wasn’t known last week? If you want to call the announcement by NBER that we have officially been in a recession since December 2007 news, maybe. But did anyone not know this?
On Wednesday morning we wrote:
“We know that historically stocks do quite well the Wednesday before and Friday after Thanksgiving Day, then pull back some on the Monday.”
“Quite well”, and “pull back some” turned out to be quite the understatement. The rallies were huge, as was the decline.
So, while we saw some of this coming, I wish I could say I was smart enough to take advantage. But being over cautious during a bear market is better than being overly aggressive. During a bull market, I’d say the opposite is true.
The S&P 500 dipped below that 840 level again and seems to have kept the downtrend alive as the overhead bearish resistance was hit and we got the reversal down.
Chart provided courtesy of www.decisionpoint.com
Recently I have been asked by more than a couple of people, about returns and why their account balances did not bounce as much as they thought it should after last week’s rally. I think maybe we should go over how returns are calculated.
two or more returns can not be added together or subtracted to get an accumulated return. That is, if your account is down 20% one month, and then up 20% the next, your account won’t be even. Similarly, if account is up 20% one month and up 20% the next, you are not up 40%.
Here are some examples:
Let’s say you started 2008 with a $100,000 account balance, it is all invested in the C-fund, and for the sake of simplicity, let’s say you don’t add any more money into it, or take any out.
The C-fund and your account drops by 50% during the first 10-months of the year, so your account is now worth only $50,000 at the end of October. If the C-fund then shoots up 50% in November, you are not making 50% of $100,000. You are only making 50% of the $50,000 you had left, or $25,000. So your $100,000 is now valued at $75,000; still down 25% for the year. (I will go over this calculation a little further down.)
If your account is down 50%, and you then have a 100% return, you are not up 50%. You are even. You need a 100% return to recoup the losses from a 50% loss.
If the a fund starts the year at $10 a share and drops to $5, it has lost 50%. In order for it to get back to even, it has to double, or make 100%.
The formula that I use to get an accumulated a total return from two separate returns is:
Total return = (100 * ((1+ 1st return) * (1+ 2nd return)) -100) / 100
Let’s plug in -50% for the 1st return, and +50% for the 2nd return and see what we get:
Total return = (100 * ((1+ -0.50 * (1+ +0.50)) -100) / 100
Total return = (100 * (( 0.50 ) * ( 1.50 )) -100) / 100
Total return = (100 * 0.75 -100) / 100Total return = ( 75 – 100) / 100
Total return = ( -25) / 100
Total return = -0.25
Total return = -25.00%
So a 50% loss, followed by a 50% gain calculates into a total loss of 25% for the account.
Just don’t forget that any 100% loss adds up to $0, no matter how big or small the gains or losses were before it. Let’s hope we never have to experience that one.
Of course we have spreadsheets available that will do it for you, or if you are an active member of our message board, we will track your return for you using our autotracker. Here’s how to get started.
That’s all for today. Thanks for reading.
Tom
www.tsptalk.com
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