The Arithmetic of Gains and Losses

Retirement fund investing is primarily about avoiding disasters. You may not realize it, but your first long-term investment objective is to prevent large losses. Here's why: Gains and losses are not symmetrical. A 20% loss requires a 26% gain to recover, a 40% loss requires a 68% gain to recover, and a 50% loss requires a 100% gain to recover.

Large losses, in the order of 30% to 50%, are historically rare, but they do occur and they are always surprising to unsuspecting investors because they tend to occur when investors feel comfortable and safe with their stock market investments.

Once a decline of this magnitude has occurred, it is impossible to predict how long it will take for the stock market to recover. In 2001-02, a decline of 40% took five years to recover - only to lose it again in 2008. In 1973-74, a 50% decline took seven years to recover - in nominal terms. Adjusted for inflation, the market didn't exceed its 1972 peak until 1989. That's fourteen years of lost compounding. No retirement investment program can successfully recover from such a devastating setback.

If you accept the principle that the avoidance of large losses is your primary long-term investment objective, then you must also accept the fact that this precludes a substantial and continuous investment in the stock market.

The 401(k) Formula^TM is designed with this principle in mind. Fortunately, the returns of the stock market are not random. The market moves in cycles and "skews" returns into well-defined time periods when the risk of loss is substantially lower than at other times. The 401(k) Formula^TM places assets into the stock market when these cyclical forces (see the "What is it?" section) create a positive market "climate" when the odds of positive and robust returns are higher than normal.