My arithmetic of portfolio losses chart shows the return necessary to break even after incurring a loss. The horizontal axis shows the assumed portfolio loss incurred. The vertical axis shows the portfolio gain required to break even.
My chart clearly illustrates that the bigger the loss you take, the harder it is to recover. You can recover from a small loss. If your portfolio drops 10%, you only need a gain of 11.1% to get back to even. But if your portfolio drops by 50%, you need a gain of 100% just to get back to even. And if you take a loss of 70%, you need a staggering 233% return to break even—which could take decades.
During the 2008–2009 financial crisis, the S&P 500 dropped 56% from peak to trough. Since the March 2009 lows, the S&P 500 has increased more than 60%, but the index is still 30% below its all-time high.
If you are in or nearing retirement, a 56% loss is unacceptable. It could be years before you recover those kinds of losses. To reduce volatility and avoid devastating bear market losses, you want to favor a balanced approach. Keep losses to a minimum. A fund such as Vanguard Wellesley Income with a 60% bond / 40% stock mix is unlikely to lose much more than 10% even in a bad year. Since the stock market peaked in October 2007, the Vanguard Wellesley Income fund is up almost 6%. The S&P 500 is still 26% below its October 2007 peak. A balanced approach is most prudent.
Note: The formula to calculate the gain required to recover from a specified loss is as follows:
((1/(1-percent loss))-1)*100.