Versus Not Losing Money
As we’ll learn later, small losses are typically not a problem for a long term portfolio. What is less obvious is the degree to which severe losses can become difficult to recover from. As the chart below illustrates, it only takes an 11% gain to recover from a 10% loss. But it takes a 100% gain to recover from a 50% loss. Effective hedges may help reduce catastrophic losses so that your portfolio may have a better chance of meeting your objectives over time.
It’s What You Keep, Not What You Make
We’re not referring to taxes here. We’re talking about the same mathematics that drive the chart above, but in reverse. Let’s say you’ve been investing for years and have doubled your money. A nice, 100% gain. Based on the math above, it only takes a 50% loss to wipe out years or, potentially, even a decade of returns.
Rather than expose your portfolio to that risk, it makes sense to attempt to protect it with something in addition to diversification.