Thursday, January 20, 2011

Perils of Bottom Picking

Compounding negative returns is not as splendid as Albert Einstein’s (if he said it at all) “most powerful force in the universe” of compounding interest or positive returns.  Drawdown is a series of traps or a compounding of really ugly negative returns.  Let’s say that you as master investor exited your $1,000,000 million position in the S&P 500 at the exact top in October 2007 at 1576.09.  You wait very patiently and based on your investment experience from 1980-2006, reenter at 1214.91 down 23% seven months later as discussed in in Barron's July 2008.  The money you don’t lose or save is not 55% (total loss to S&P) – the 23% you missed.  Rather, it is still a very painful loss of 44% and it does not seem so genius even with a genius exit.  This trap hurt a lot of supposed geniuses that earned that reputation from 1980-2006.

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1 hour

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