Math alert! This is an interesting way to show students one of the most important tenets of investing which I might summarize in an informal way as “Avoid Disasters.” What are disasters? Well, it might be my initial foray into investing in 1989. I bought a stock called CheckRobot (it pains me to even type these words). A revolutionary company to bring self checkout to supermarkets. Labor savings, great ROI, a management team. All the ingredients for a phenomenal investment, right? Let’s just say I was a little early. A year later the stock was down 83% and the pain of opening my brokerage statement every month (pre-Internet days so no online access) eventually led to a sale and an important lesson learned. And no, the stock price never did recover.
Sorry for the digression. Back to the example. Most students will have a gut reaction that if a stock price falls 50%, well it has to increase 50% and then you will be back to even. Aha, a learning opportunity! Take an example:
- You purchase SureThing Labs at $10/share
- It drops 50% (stock price is cut in half) and now the share price is at $5/share
- How much will the stock price need to increase to get from $5 back to $10/share?
Voila, the stock price would need to double (or a 100% increase), which is quite a large hill to climb. How to put this lesson to work. Avoid Big Disasters (like CheckRobot) and instead diversify your portfolio by holding a variety of assets.