Losing Money Is Easier Than Making It Back

Small Investors Pile Into Funds Devoted to Riskier Investments - WSJ.com:

"Murray Schofield, a retired orthodontist in Arizona who sold most of his foreign investments in the second half of 2008, has been buying emerging-market funds, and funds dedicated to China and India, since March. He now has 23% of his portfolio in funds that invest in these stocks. “I have to recapture part of my losses,” says the 84-year-old. “Otherwise I’d be more conservative.” His portfolio is up 20.4% for this year, following a 44% loss in 2008, he says."

I have bolded the last sentence attributed to Mr. Schoefield because it demonstrates a natural flaw in people's thinking when it comes to percentage losses and gains towards recovering them. A common error is to see the 44% loss and the subsequent 20.4% gain and do a quick back of the envelope calcuation that he is down 23.6% now.

That is wrong. The back-of-the-envelope calculation is to take the 20.4% gain and multiply it by the 44% loss to see how much Mr. Schoefield has recovered - about 9%. That still leaves him down about 35% from start of 2008. (A performance measurement professional would say from 12/31/2007.)

To see how far he is actually down, assume $100 on 12/31/2007. A 44% loss in 2008 would leave him with $56. In the first half of 2009, he has gained 20.4%. $56 plus ($56*.204) equals $67.42. Or still down a cumulative 32.58%.

FWIW, Mr. Schoefield will need to see an additional 50+% return over the next six months to get his portfolio back to its 12/31/2007 value.