Stock Market Math

January was not a good month for the stock market. It happens. That is why it is important to hold an age appropriate balance between stocks and bonds.

Consider a 50% drop in the market (that almost happened in 2008-2009).

If you had 100% of your holdings in stocks you would lose ½ your money. In order to get back to even you would then need to double your money. That is very hard to do. Even with a 12% return, the rule of 72 tells us it would take six years to break even after such a loss.

Starting Balance: $100
After Crash: $50

72/12= six years to double your money at 12%

Final balance after six years: $100

If you had 50% in stocks and 50% in bonds you would only lose ¼ of your money. Now what happens?

First you rebalance

Starting balance: $50 in stocks + $50 in bonds = $100
After Crash: $25 in stocks + $50 in bonds = $75

After Rebalancing: $37.50 in stocks + $37.50 in bonds = $75

In six years at 12% return on your stocks and 4% return on your bonds you now have

Final balance after six years: $75 in stocks + $46.50 in bonds = $121.50

That is why even young folks who have all the time in the world to save for retirement need to keep a little of their powder dry. Even in you are in your twenties you need to hold 15% or 20% of your 401K in bonds. Then a crash in the market still hurts but it also becomes a once in a decade opportunity to pick up some quality shares at bargain prices.

One more thing; Let’s be careful out there.