TO SUCCEED AS an investor, you don’t need to turn yourself into a “quant”—Wall Street lingo for a quantitative investor. But it is helpful to have a grasp of basic investment math, so you appreciate how time can magnify the virtues of saving regularly and investing in the stock market, but also how it can magnify the damage done by high investment costs and an overly aggressive investment strategy.
This might sound daunting. The ideas involved, however, are quite simple. Often, you don’t even need to do the calculations yourself, because there are plenty of online calculators that’ll do the work for you. Instead, what’s important is having a rough understanding of how the math plays out.
Everyday investors often struggle with three key notions. First, when presented with a series of investment returns, their inclination is to add them together. But simply adding the numbers fails to take into account the amazing way that money compounds, with each year’s gain building on earlier returns.
Second, folks fail to grasp that losses hurt more than gains. If you lose 20% this year, you would need a 25% gain to get back to even. Think of $1 that loses 20% of its value, so it’s now worth 80 cents. To get back to $1, the necessary monetary gain might be 20 cents—but the percentage gain, to get from 80 cents to $1, is 25%.
Third, when percentages get into triple digits, investors often struggle to understand what the numbers represent. Suppose your money grows 100%. That would double your wealth. What if the gain was 200%? That would triple your money.
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