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STA Weekly Report – The Math of Investment Returns

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The Math of Investment Returns
Weekly Technical Comment
Six Things to Consider Before Retiring From Your Business
401k Plan Manager

Most investors know the math associated with getting back to “breakeven” after sustaining a loss. The example that is typically given is that it requires a 100% return to recover from a 50% loss. In other words, to get back to even, the math of returns requires that an investor must participate in a more substantial rally to recover from the initial drawdown or loss.

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However, a point that is sometimes missed is that this math has some embedded asymmetry that every investor should be aware of. More specifically, the gain required to get back to even from a portfolio loss of 15% or less is a ratio of approximately 1-to-1. Once the loss is greater than 15% the ratio shifts out of the investors favor.

Take for example a loss of 5%. It requires only 5.26% to get back to breakeven. 5% divided by 5.26% is a ratio of approximately 1-to-1. At 15%, a similar thing happens with a 17.65% gain required to get back to breakeven, a return/loss ratio also very close to 1-to-1. However, once an investor experiences a loss of greater than 15%, the ratio of return/loss needed to achieve breakeven is magnified. Take a 25% loss which requires a 33.33% gain to get back to even. The return/loss ratio there is less favorable for the investor. As the losses get larger, the required return to get to breakeven become almost impossible to achieve. Just look at the return required to get back to even from a 90% loss in the table below (It would require a whopping 900% return).

Source: STA Wealth Management

This data is valuable for the investor on two fronts.

First, it provides mathematical support for why investors should be more concerned about minimizing large losses rather than the smaller day-to-day fluctuations in the market. Having that insight can allow an investor to sleep well at night when a disciplined risk management approach designed to reduce the impact of large market declines is in place. And mind you, while these declines are rare, they do occur.

US Market is measured by the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year.

Source: DigitalWealth

Second, and this speaks to the importance of knowing upside/downside capture in your portfolio, is that for losses greater than the 15% level, as long as your downside capture is less than 100%, it is possible to take advantage of other asymmetric properties of return. And this may be surprising to most investors — Up-capture can in fact be lower than the down-capture and still result in a favorable investment outcome through a market drawdown and recovery.

How a higher down capture and lower upside capture can still work for you

Let’s take for example, a market that sustains a loss of 50% and a subsequent recovery of 100% to get back to breakeven. Let’s assume in this scenario that your portfolio has a downside capture of 60% and an upside capture of 70%. In this scenario, the capture ratio would result in a portfolio value 19% higher than where it started when the market completes its recovery, and falls in line with what most investors might expect when the upside capture is greater than the downside capture.

Let’s now see what happens in a situation where the upside and downside captures are reversed, with a downside capture of 70% and upside capture of 60%.

The result would be a portfolio increase of 4% after the markets’ round trip. This may be surprising to most investors as most believe that it is necessary to have a higher upside capture than downside capture to have positive performance through a drawdown and recovery. However all you need is a downside capture of less than 100% to make this math work.

Understanding this mathematical relationship leads to an encouraging conclusion – it is not necessary to time the market with precision to get absolute outperformance over the market. Instead, it shows that following a discipline based on reducing risk exposure when markets show signs of deteriorating and adding risk exposure when markets show signs of stable improvement can be enough to generate favorable investment outcomes that meet your goals.



Start of the Third Quarter

Monday started the third quarter of 2018 with a stumble as investors continue to wrestle with the uncertainty around trade and tariffs. The intense market volatility runs in both directions. All the while, the S&P 500 has not made a new high since January 26th and longer we go, the firmer the conviction that we are in the midst of a topping formation.

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This is the problem of having all the good news from deregulation to tax cuts already in the price, coming off a January that say a performance in the stock market in one month that generally takes a full year to achieve.

Second Quarter Leaders and Laggards

Stocks gained ground during the second quarter. The Russell 2000 Small Cap Index led with a +7.4% gain, with the Nasdaq in second place at +6.3%. The S&P 500 rose +2.9% while the Dow lagged with a +0.70% gain. Eight sectors rose during the quarter. Chart 2 shows the four that outpaced the S&P 500 being energy, technology, REITs, and utilities. Energy stocks gained on rising energy prices, while utilities and REITs benefited from a drop in bond yields during May and June. Technology retained its role as a market leader. That’s important since technology is the biggest sector in the S&P 500 (23%). Chart 3 shows the two weakest sectors during the quarter being industrials and financials. [They were also the two weakest sectors during the month of June]. Why that matters is that their combined weight of 26% in the S&P 500 more than offsets the 23% weight in the stronger technology sector.  Consumer staples also lost ground but have a smaller weight of 7%. Financials have the second biggest weight in the S&P 500 at 16%. So, what they do really matters. Let’s take a look.

Financials Still in Downtrend

Financials have been the year’s third weakest sector with a loss of -4%. Only staples and industrials did worse with losses of -9% and -4.5% respectively. Chart 4 shows the Financial Select SPDR (XLF) forming a negative pattern of falling peaks and falling troughs since its January peak. The only good news is that the upper trendline drawn over its peaks is falling faster than the lower trendline drawn under its troughs. Chart readers will recognize those two converging trendlines as a potential “falling wedge” pattern which often carries bullish implications. The fact that its 9-day RSI line (top box) is oversold is encouraging. So is the fact that its 50-day average remains above the 200-day line. But the XLF is trading below that 200-day line. And its MACD lines (lower box) remain negative. What the XLF needs to reverse its downtrend is for prices to rise high enough to break the upper trendline. Bank stocks are the biggest part of the XLF (44%). They’re in a precarious position as well.

Weekly Snapshot of Global Asset Class Performance

If you have any questions, please feel free to email me at


STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)


Six Things to Consider Before Retiring From Your Business

(Forbes Financial Council Highlights from June 2018)

I was recently asked to join the Forbes Financial Council.  As I have talked very much in depth on the STA Money Hour about Business Exit Strategies and Business Succession Planning, the Forbes Finance Council asked me for my input about Six Things to Consider Before Retiring from Your Business.   In this article, they asked several members about how business owners can coordinate their Business Succession Planning with their overall Retirement and Financial Plan.

For many business owners, a business is their life’s work. For others, a business is a primary source of income: one that has allowed them to live the life that they’ve worked hard to create. Whatever the result, a successful business must be protected because no business owner can work forever. When an owner is ready to retire, it’s too late to consider what should have been done.  With that in mind, they asked me and other members of the Forbes Finance Council how a business owner can prepare for retirement and leave a business in the best possible state. The answers pointed at long-term planning that will ease a business owner into a comfortable, worry-free retirement.

For my part, I suggested:

Create a personal financial plan. Take the time now to coordinate your personal financial plan to protect your family and help assure the highest value you could receive at retirement. Business owners may spend 50 or more hours a week worrying about their business. That being said, in many cases, their largest asset is their business. For decades, vast wealth has been created for millions of Americans through growing private businesses. As Baby Boomer business owners reach the later stages of their careers, the 2016 U.S. Trust Wealth and Worth Survey shows that nearly two-thirds have no formal succession plan or exit strategy. Since most business owners rely on their businesses for income, the lack of such planning means that their main source of income could be in jeopardy.

To read the other 5 Suggestions, visit the article on our website at:








Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor. STA does not provide tax or legal advice and the information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice



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