Frequency of Investment Losses

There are many, many facets of investment risk and uncertainty. I catalogued a bunch of them in March 16’s post. Today’s post focuses on just one aspect of investment risk: How frequently can you expect to experience a loss?

First, let me narrow the inquiry. How frequently might you expect to experience a real, i.e., inflation-adjusted, loss? If you just look at the nominal value of your account, your perceived losses will be much less frequent. But we’re much too wise to ignore the hidden loss engendered by inflation. So we’ll ask the question “How frequently can you expect the inflation-adjusted value of your account to decline when you invest in different asset classes—stocks and bonds?”

Not surprisingly, the answer depends on how frequently you look at your account statement. The shorter the interval, the more frequent the incidence of real loss. Time erases all losses. Time also erases outsized gains, but that’s an inquiry for another day; today we look at losses.

If you look at your investment results every calendar year you’ll find that a sickeningly high percentage of the time you will have realized an inflation-adjusted loss. 33% with stocks and 39% with bonds. Where did these percentages come from? I looked at the 83 years from 1926 through 2008 (yes, that horrible 2008). For stocks, I measured the total return on the S&P 500; for bonds, I measured the total return on intermediate term treasury bonds; for inflation, I measured the change in the Consumer Price Index.

But if you expand the interval between measurements—increasing the interval from one year to every two years, things improve a bit. The percentage of losing periods drops to 27% for stocks and 32% for bonds. And so the trend continues, as shown in the graph below. Although the trend is more pronounced for stocks than for bonds. By the time your time horizon increases to 18 years, you find that stocks have not shown a real loss for any period of 18 years or longer between 1926 and 2008. For bonds, the magic number is somewhat higher—the interval has to be 50 years before you can say bonds have never exhibited real losses during the 83 years studied.

So time heals all losses. But there’s four hairballs on this particular lollypop: (i) the future might be worse than the past; (ii) you might simply not have enough time to recoup your losses; (iii) the scariness of the ride along the way (think 2008) might cause you to change your asset allocation in ways you’ll later regret; and (iv) the graph says absolutely nothing about the magnitude of losses, just the frequency. Magnitude is for another day.