I want to share an insight on financial risk management that we covered during one of my group coaching sessions.

We were considering the use of ‘stop-loss’ orders as a mechanism to protect investors from volatility in the markets. I asked my clients to consider the impact of a potential loss on any investment.

I put it to them that losses and gains are asymmetrical. Mathematically speaking, its much harder to recover from a financial loss than it is to make the loss in the first place!

Let me illustrate with a few examples:

Scenario 1

Let’s assume you start with $100.
If you make a 20% loss, then you will lose $20.
So you’ll be down to $100 – $20 = $80

Now, if you wanted to recover back to your original $100, then you would have to make up the $20 shortfall.
This is actually equivalent to a 25% required gain ($20 is 25% of $80)

So a 20% loss requires a 25% recovery.

How about a deeper loss…

Scenario 2

If you re-started with $100, but this time made a 50% loss then you would lose $50 (since 50% of $100 is $50).

The tricky bit…
If you wanted to recover from $50 to $100, you would have to double-your-money and somehow make a 100% gain.

So in this case, a 50% loss requires 100% recovery.

Scenario 3

If you go to an extreme and experience a 90% loss then your $100 would shrink by $90 to only $10.

To go from $10 to $100 means you have to 10x your money (its actually a 900% gain for the mathematicians out there).

This asymmetry is what impacts those investors who don’t have the appropriate tools, technique and knowledge. Many newcomers fail to realise this, take on unnecessary risk and severely dent their returns.

Key Point

You can see that its really important to manage your investments and reduce your losses as much as possible. Sensible risk management involves cutting your losses early and letting your winners run. That’s what successful investors do.

Want to find out more?

Would you like to join me for a 30 minute “virtual coffee” chat so that we can explore ideas like the above? If so, here is a link to my online calendar where you can pick a suitable date and time for us to meet.