Cutting losses
Cutting losses

Barry Ritholtz posted this table detailing the relationship between percentage losses and the consequent percentage rises needed to return to your starting point:

He makes the point that:

“It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”

You can’t argue with that point. But it also makes me question the whole extent and pretend philosophy underlying many governments reactions to the Global Financial Crisis. Surely it highlights just how important it is to recognize losses promptly and rapidly take remedial action. Changing accounting standards to hide them does not seem to fit unless you are certain the losses will reverse themselves. If they do not then the above chart suggests it gets very difficult to rapidly make your money back.

It also emphasizes how damaging the cognitive bias against recognizing sunk costs really is.