We've all heard Warren Buffet's rules for investing.
Rule 1: Don't Lose Money
Rule 2: Don't Forget Rule 1
No investor ever wants to lose money because not only did they just lose money, but it's a validation of the fact that they were wrong.
Just how bad is a loss and how long does it take to get back to even?
As you can see in the chart, it'll take almost 5 years just to get back to the original amount if you are able to then earn 15% per year after the loss. A more realistic number would be that you could earn 7% per year after the loss. This would require over 10 years to get back to the original amount.
Here's another way to look at it based on required total return going forward based on different loss percentages.
Of course, this is just to get back to the original amount in nominal terms. Assuming that it would have been earning a return would just push the break-even point further back.
You can use the following formula to calculate the number of years to get back to the original amount, where P = original investment, L = % loss, R = rate of return going forward, and n = number of years
I have created a spreadsheet where you can run your own numbers that you can access here.
Since making up for a loss requires several years at an average rate of return, this is why I prefer to use dividend growth stocks. In general they are more stable companies that have been through multiple economic cycles, coming out stronger through each one. Not only are dividend growth stocks typically more stable, but you are receiving something tangible from them, the dividend. Dividend payments will provide a return, even in the darkest times of the stock market or economy and will help to keep you invested instead of turning your back on the markets during the best time for net purchasers of stocks.
This also reinforces how important your purchase price is. The right purchase price will provide better returns going forward as well as allow for a margin of safety between the true value and your purchase price. I've been building my cash position recently in order to avoid overpaying for my investments. Most stocks that I'm interested in aren't grossly overvalued but they are higher than what I would like to be paying for them. Eventually the markets will turn again and provide opportunities to further increase the dividend stream from my portfolio.
I'll end with another nugget from Warren Buffet, "Price is what you pay, value is what you get."