The Counterintuitive Stock Market Strategy: Lose Less

In 2020 my wife and I purchased a Peloton exercise bike. We had read wonderful reviews about the product and hoped it would allow us to continue our exercise routines even though the gym was closed due to COVID. We loved our Peloton so much that we decided to invest a small amount of money in Peloton stock. We bought shares at a price of $60. After the purchase, we excitedly watched the price nearly triple in value, eventually hitting $167 per share.

We regretted not buying more shares and it never crossed our minds that this was a perfect time to sell. Instead, we traded high fives and confidently anticipated that the price would continue to rise. Everyone was ordering Peloton bikes, right? Well, yes, a lot of Pelotons were being sold, but no, the stock did not rise further. In fact, it fell—a lot. Just a year and a half after we celebrated its rise to $167 per share, we found ourselves stubbornly holding our original shares, then trading at $7.50.

Since our initial purchase at $60 per share, our shares were down 86%, and from the high of $167, they were down a whopping 96%! Ouch! Various thoughts crossed our minds including, “Wow, I’m glad we didn’t invest a lot more money in this,” and “Gee, I wish we had sold at the top!” We had other thoughts that I won’t mention here. We’d had a bad investment experience, and learned an important lesson, to put it lightly.

My experience with Peloton stock serves as an important reminder about investment losses, especially large investment losses. It is very difficult to recover from large losses. Warren Buffett is known for saying, “Rule Number 1: Never lose money. Rule Number 2: Don’t forget rule number 1.” Those are simple but strict rules aren’t they? Why is he so focused on avoiding losses? I’ll suggest that he is concerned with avoiding large losses. It is hard to dig out of a deep hole. The larger your percentage decline, the increasingly larger the return required to get back to even.

A simple example makes this clear. If I lose 10%, a return of 11.1% is required to break even. If I lose 50%, a return of 100% is required to break even, a much larger hurdle! In the case of the Peloton stock my wife and I bought, we watched it fall 96% from a high of $167 to today’s price of approximately $7.50. We actually still hold our position and will plan to take a tax loss when needed. We certainly don’t anticipate it becoming a gain. I did the math. To get back to break even ($60 per share) would require a return of 700%. To get back to the all-time high of $167 would require a return of over 2100%! One need not be a statistician to conclude that those outcomes are very unlikely.

The table below shows how the percentage gain required to recover from a loss exceeds the percentage loss from which you wish to recover. And increasingly so!

Avoiding large losses is a central tenet of our portfolio philosophy at Bragg Financial. It has three primary influences on the portfolio we construct for clients. First, we diversify, by security type (stocks, bonds, cash, etc.), by asset class (US Large Cap, US Small Cap, Foreign equity, etc.), by sector weight (healthcare, financials, technology, staples, etc.) and finally, by position size. Second, we have a value tilt in the portfolio. Simply put, this means we favor the stocks of established companies that trade at reasonable valuations and that have a demonstrated history of increasing earnings. And finally, we rebalance the portfolio without emotion. This results in our trimming relative winners and buying relative losers. Sell high and buy low, if you will.

Returning to the roller coaster ride in the stock of Peloton that my wife and I endured, we broke a number of Bragg’s rules for portfolio construction. Now for sure, we only invested what we were willing to lose in Peloton stock but admittedly, for a short time there when it was hitting new highs each day, we wished we had invested more! In the end, of course, we were thankful we had not. Perhaps the biggest rule we broke was our failure to ignore our emotions and rebalance. We should have trimmed our winner. Instead, we shared high fives and enjoyed that euphoric feeling that often precedes a great loss. Legendary investor Sir John Templeton once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” He made this observation after a long investing career. Like some of my co-workers at Bragg (the gray-haired ones), he had seen numerous market cycles, and many times he had heard the words, “It’s different this time.” Templeton recognized that every generation must learn these investing lessons, and usually the hard way. I hope my Peloton confessions help you, a friend or family member avoid learning the hard way. Please let us know if you would like to discuss your portfolio.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.