Difficult to make up losses
It is mathematically harder to make money than it is to lose it. Consider a $1,000 investment in a stock that goes down fifty percent in year one and then goes up fifty percent in year two.. You will not be even after two years, rather you will be down 25%!
0.50 x $1000 = $500
1.50 x $500 = $750
What if the investment goes up the first year fifty percent and down the second year the same fifty percent?
1.50 x $1000 = $1,500
0.50 x $1000 = $750
Either way you look at it, you lose money big time! I believe this is one reason the stock market pays so well for consistent earnings growth and punishes so heavily when companies come up short of analysists estimates for income. Consistent growth is so much better than alternating good and bad years as my simple example shows.
For the individual investor, the lesson to learn is to not take so much risk that you might have a year of significant relative negative growth in your portfolio.
Investment Risk Pyramid
I was taught when I first started investing by a commissioned broker that one builds a portfolio of risk that stacks up like a pyramid . A smart investor allocates the risky investments weighted like the top of a pyramid (maybe 5% in a volatile sector or stock), the very secure investments weighted like the base of a pyramid (40 to 60% invested in large cap blue chip stocks and B or Higher rated bonds) and intermediate risk as the center of the pyramid. This pyramid structure gives you a base of good growth and returns no matter how well your risky 5% does and you hope you break even or better on the middle of the pyramid.
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