By Indexopedia Research Team | December 10, 2024 | In
Compounding is one of the most powerful tools in wealth building. By allowing returns to generate additional returns, it creates a snowball effect that can significantly enhance an investor’s portfolio over time. However, compounding can also work in reverse when markets decline, and this negative compounding can likewise drastically reduce long-term portfolio growth. Fortunately investors can mitigate these dangers and potentially position themselves to rebound more quickly from market downturns. The Harmful Impact of Negative Compounding When a portfolio loses value during a down market, the math to recover becomes much more challenging. A 20% loss, for example, requires a 25% gain just to break even. A 50% loss? That demands a 100% gain to recover. This is the essence of negative compounding–the deeper the loss, the harder it is to regain the lost ground. Consider an investor with a $2 million portfolio. A 30% market drop would reduce the portfolio to $1.4 million, and a 43% gain would be needed to restore the portfolio to its original value. This is a tough ask during times of economic instability, but there are strategies that can