Break-even math: How much gain is needed to recover from a loss fully?

Narratives help investors make sense of market trends, but there’s a danger in following them without critical assessment or an objective perspective. One narrative tested over the past year has been that disinflation, or a fall in inflation, should result in a decline in interest rates. The actual trend in interest rates for much of this year, where rates have risen even as the pace of inflation growth has slowed, seems to defy this narrative.

Since the peak of the inflation cycle in June 2022, when the Consumer Price Index (CPI) annual growth rate hit 9.1%, the yield on the 10-year Treasury has climbed approximately 140 basis points, from around 3.0% to 4.4% as of late. In another paradox, the 10-year Treasury yield is up about 50 basis points since the “Goldilocks” CPI reading in July 2023.

Blind faith in market narratives can hamper investors’ ability to understand risk. Investors often need to pay more attention to the impact of a significant loss on a single investment and realize that a more substantial gain is required to break even. As illustrated in the accompanying chart, as the loss on an investment increases, the gain necessary to recover fully from that loss rises exponentially. For instance, to recover from a 10% loss, an investor needs an 11% gain. To recover from a 50% loss, an investor needs a 100% gain. During the bear market of 2007-2009, the S&P 500® Index lost approximately 55%, which required an approximate gain of 123% to break even.

Understanding the importance of recovery time, or the number of months potentially needed to break even, can help investors make informed decisions on asset allocation and risk management. Rather than basing investment decisions on narratives or emotions, a well-structured investment plan is personalized to an investor’s specific risk tolerance, objectives, and time horizon, helping to create a resilient portfolio for the long term.