What Will It Take to make up those losses?

The terrible market declines of the past year have investors everywhere licking their wounds and toting up their losses, even as they prepare for the possibility of more losses to come. Nearly every portfolio that holds stocks is down significantly since late 2007, with 40% declines not uncommon. Just about the only solace is the thought that the market is bound to turn around at some point, and then people can start making up some of the ground they've lost.
But what, exactly, will it take to make up those losses? Many people underestimate the gains needed to recover from big investment losses, and the extent to which additional losses put you deeper in the hole. Amid all the current market gloom, it's worth taking some time to understand what it might take to recover from the current market swoon.
Climbing Out of the Hole
Suppose you hold a stock or a fund that falls 50% in value. How much does that stock or fund have to gain before you're back where you started? Many people instinctively say 50%, but that's wrong. If the stock's price starts at Rs.10 and loses 50%, it's at Rs.5; from there, gaining 50% would put it only back up to Rs.7.50. To get back to Rs.10, the stock would have to gain 100%, twice as much as it lost in percentage terms.
Recouping losses always requires a larger percentage gain than the loss itself, and the difference between the two gets more dramatic as the losses get larger.
For example, a stock had lost 10.1% over the past year, meaning it will have to gain 11.2% to recoup that loss, and if another stock had lost 30% over the past year, but it will have to gain 43% to get back to where it was a year ago.
Once the losses exceed 50%, as they have for many stocks, the numbers get even uglier. For example, a stock has lost 68% of its value over the past year, meaning it would need to more than triple in price (gaining 214%) in order to make up for that loss.
Easing the Pain
All this may seem a bit depressing, and it is, but it highlights the importance of diversification. If you had your entire life's savings invested in one of the stocks that have completely imploded, your portfolio would be critically damaged and would be facing a long recovery. But, of course, very few investors have all their money tied up in a single stock, and with good reason; diversifying your holdings helps stabilize a portfolio and lessens the chance of one investment torpedoing returns. Even in a market where everything is down, like last year, moderating your losses can make it much easier to bounce back.
The best way of diversifying a portfolio is through asset-class diversification. In addition to making sure your portfolio is diversified by asset class, it's also important to ensure that its spread across different industries and individual securities.
One very basic rule of thumb for determining a good stock-bond allocation is to subtract your age from 100, which gives a rough estimate of the percentage you should have in stocks. Thus, if you're 50 years old, it's a good idea to have 50% of your portfolio in stocks; if you're 60, it makes sense to have 40% in stocks; and so on. Alternatively, tools like Asset Allocator available in www.moneycontrol.com or www.mutualfundsindia.com can help you arrive at a customized stock/bond split.