Good morning & happy Monday!
“It’s the nature of stock markets to go way down from time to time. There’s no system to avoid bad markets. You can’t do it unless you try to time the market, which is a seriously dumb thing to do. Conservative investing with steady savings without expecting miracles is the way to go.”
– Charles Munger, vice-chair of Berkshire Hathaway (Warren Buffet’s company)
Last week I referenced the fact that ups and downs do not equal each other in investments, and I wanted to elaborate a bit further on that topic.
Numbers can be tricky, math trickier, and statistics can be just downright insane. I’ll deal with statistics another time (next week maybe), but today we will dive a bit into some math (careful, I can get really nerdy really quickly in this space 😉)
Let’s say I have $100,000 that goes up by 20% … how much would my account be worth? $120,000, a $20,000 gain.
What about if that $100,000 goes down by 20% … how much would my account be worth? $80,000, a $20,000 loss.
On the surface these seem to be identical scenarios where ups and downs are the same. But, when we combine ups and downs that is where they stop being equal.
Same $100,000 example: let’s say the account goes up by 20% and then down 20% … it would be reasonable to assume that I would be back to $100,000 but in actuality my account would be worth $96,000.
What?!?!
Let’s do the math.
$100,000 + 20% gain = $120,000
$120,000 – 20% loss = $96,000
$100,000 – 20% loss = $80,000
$80,000 + 20% gain = $96,000
It’s not good or bad, it’s just math. And I believe it is important to be aware of how math works so we can be wiser investors … and wiser shoppers.
Math games are frequently used in retail shopping to make us think we are saving more than we actually are. If I have a 25%-off coupon and an item is already discounted by 25% our brains will think we are saving 50%, but in reality we are saving 43.75%.
$100 item – 25% discount = $75 sale price
$75 sale price – 25%-off coupon = $56.25
If it’s a sale on top of a sale with a coupon the math becomes even more complicated (and the actual savings diluted)
“Save an extra 25% off the already 25% discounted item” plus a 25%-off coupon. It’s not 75% off … here’s the math:
- $100 – 25% sale price = $75
- $75 – additional 25% discount = $56.25
- $56.25 – 25%-off coupon = $42.19
We think it’s a 75% savings, but when the math plays out it’s only 57.81%.
Math is wonderful, but it can be manipulated if we are not careful. Salespeople and politicians can use very crafted math and statistics to manipulate us and paint a story that is very different from reality.
Statistics opens up a whole additional can of worms, I’ll address that next week. To be continued … 😊
Give me a shout anytime I can be of assistance. I know some of these concepts can get a bit in depth.
Hope you have a wonderful week ahead!