Every investor must learn the one investing lesson in surviving the long game: how math works. I recently received an email from a reader suggesting that the 2022 decline in the market is “no big deal” because of the stellar returns over the last decade. He quoted a snippet of an article by Ben Carlson.
“To be fair, these losses need to be put into perspective. The gains leading up to this slaughter were gigantic. These are the annual returns for the Nasdaq since the Great Financial Crisis ended:”
- 2009: +45.3%
- 2010: +18.0%
- 2011: -0.8%
- 2012: +17.9%
- 2013: +40.9%
- 2014: +14.7%
- 2015: +7.0%
- 2016: +8.9%
- 2017: +29.6%
- 2018: -2.8%
- 2019: +36.7%
- 2020: +44.9%
- 2021: +22.2%
For those of you scoring at home, that’s returns of more than 20% per year for 13 years!
Ben’s math is correct. As such, the reader’s email suggests the 2022 drawdown is nothing to be concerned with because of gargantuan percentage returns in previous years. To be exact:
“Yes, I gave up 2021 gains, but I still have all the previous years in the bank.”
Unfortunately, that isn’t how math works; therein lies the investing lesson we must learn. As shown, corrections that seem small on a percentage basis can wipe out years of gains.
Investing Lesson – How Math Works
“The following chart proves my point, in the long-term; bear markets are harmless (and relatively small) as the chart indicates.”
For data consistency, I recreated the “cumulative percentage return” chart that the reader provided from First Trust.
If you fail to analyze the chart above, you would undoubtedly agree that market drawdowns are significantly smaller than the previous advances.
The problem is that your assumption is entirely wrong. The investing lesson buried in the chart above is the basic understanding of math. The chart uses percentage returns which is highly deceptive if you don’t examine the issue beyond a cursory glance. Let’s take a look at a quick example.