Principle #1 – The Regeneration Principle

Definition:

1. to recover from a loss, you need a multiple in gain.

As Warren Buffet is reported to have said, “I’m more concerned about the Return Of my Investment than I am about the Return On my Investment.”

As we start to define these principles you will find that most of them are simple arithmetic, basic mathematical formulae. It only makes sense that if are dealing with money, then math will play its part. Let’s break down this definition of The Regeneration Principle with the following example:

Initial Investment = $100

Loss Suffered = (50%)

Remaining Investment $50

Formula $100 x (50%) = $50

You must admit that this is pretty simple! If you start with a $100 investment and that investment declines in value by 50% you will have only $50 leftover. Moving on, if that remaining investment were to increase in value by 50% it would look like this:

Remaining Investment = $50

Increase on Investment = 50%

Gain = $25

Remaining Investment + Gain = $75

Formula: $50 x 50% = $25; $50 + $25 = $75

You see if you lose 50% on an investment and then you are fortunate enough to earn 50% on the remaining funds you are not back to 100%, not even close. The Regeneration Principle states that you need a multiple in gain to recover from a loss. In this instance you would need to earn TWICE as much as your loss just to break even!

Formula: $50 x 50% = $25 x 2 = $50; $50 +$50 = $100

Is this a BFO? For many it will be, for others not so. Why? The reason it won’t be so obvious is that we have been conditioned to not see the reality that avoiding losses is more important than making gains. What I mean by this is that if you read the popular financial press you will always see something like this…

… if you look back at the S & P 500 over the past 90 years you would see that the average rate of return was over 12%….

By the way that percentage will vary from source to source, however, the message is the same. That is, if you invest in the stock market over a long period time you will make money. Frankly, you will IF you never take your money out of the market. Unfortunately, most of us we will need to spend our money at some point and when we do, that theoretical, hypothetical, mystical 12% return falls apart completely. Let me explain further using the example below:

In this example I chose some random numbers to represent the gains and losses in the market. If you total all the gains and losses together they equal a gain of 192%. That would be a total Return of Return or ROR. Because this sample ran for 16 years, you need to divide the Total ROR by 16 to end up with an Average ROR or 12%.

% Gain/Loss
25%
8%
10%
-15%
35%
63%
-2%
20%
15%
-10%
29%
25%
17%
-3%
-10%
-15%
=============
192%	Total ROR
12.0%	Average ROR

Now it gets fun! You see there are those who will tell you that what really matters is when the gains and losses occur. That is, if the gains occur the early years of your investing and the losses occur later years, then your overall returns would be lower. That premise, however, is patently false as I illustrate in the following example where I reverse the order of my numbers.

% Gain/Loss	Reciprocal
25%	-15%
8%	-10%
10%	-3%
-15%	17%
35%	25%
63%	29%
-2%	-10%
20%	15%
15%	20%
-10%	-2%
29%	63%
25%	35%
17%	-15%
-3%	10%
-10%	8%
-15%	25%
============	==========
192%	192%	Total ROR
12.0%	12.0%	Average ROR

As you can see, by using these reciprocal returns I still end up with the exact same ROR. Why? It’s simple Algebra (Isn’t that an oxymoron!) where the values are as follow:

A x B x C = C x B x A

It does not matter which values come first or last as all the numbers are multiplied together and the result is always the same. So let’s dig a little deeper by reviewing The Regeneration Principle once again. Remember, to recover from a loss you need a multiple in gain. Therefore, let’s see how this plays out with our investment.

Starting with a $100 investment I earn 25% in the first year. Then, I lose 25% the following year. Moving back and forth I continue to make the same gains and losses. Then, when I add up the total percentage gain it equals 0%.

Initial Investment	$100

% Gain/Loss	Amount Gain/Loss	Total
25%	$25	$125
-25%	($31)	$94
25%	$23	$117
-25%	($29)	$88
25%	$22	$110
-25%	($27)	$82
25%	$21	$103
-25%	($26)	$77
25%	$19	$97
-25%	($24)	$72
25%	$18	$91
-25%	($23)	$68
25%	$17	$85
-25%	($21)	$64
25%	$16	$80
-25%	($20)	$60
============
0%	Mythical Total ROR	-40%	Actual Change in Account Value

Now, look what happened to the actual amount of your investment. Instead of being at $100 which you would expect from a 0% loss/gain, you find that you only have $60. This represents a 40% loss on your investment. Again, The Regeneration Principle states that you need a multiple in gain to recover from a loss. This example clearly illustrates this principle.

Now, let’s look at what will happen if you actually withdraw money from your investment. Yes, at some point we will want/need to spend our money and generally, by the way, we need to spend our money at retirement, a time when we no longer have a job to earn back any losses we may incur.

In the following example I am going to withdraw only 5% of my investment or $5. The result is that despite the fact that my Total ROR remained at 0%, now my account value is -100%. My money should have lasted 20 years ($100 / $5 = 20 withdrawals), however, despite breaking even on my Total ROR I am completely broke in 16 years!

Initial Investment	$100
Withdrawal	($5)

% Gain/Loss	Amount Gain/Loss	Before	After
25%	$25	$125	$120
-25%	($31)	$89	$84
25%	$22	$106	$101
-25%	($26)	$74	$69
25%	$19	$88	$83
-25%	($22)	$61	$56
25%	$15	$71	$66
-25%	($18)	$48	$43
25%	$12	$55	$50
-25%	($14)	$36	$31
25%	$9	$40	$35
-25%	($10)	$25	$20
25%	$6	$26	$21
-25%	($7)	$15	$10
25%	$4	$13	$8
-25%	($3)	$5	$0
=============
0%

0.0%	Mythical Total ROR	-100%	Actual Change in Account Value

Now let’s look at an example with our random numbers again. With the same withdrawal rate of $5 (5% of the original investment) you can see that your money continues to grow despite the losses incurred. In fact, at the end of 16 years you have beat the average hypothetical ROR or 12% (I refer to it as “Mythical”) and your account value is up 15% instead.

Initial Investment	$100
Withdrawal	($5)

% Gain/Loss	Amount Gain/Loss	Before	After	% Gain/Loss	Amount Gain/Loss	Before	After
25%	$25	$125	$120	-15%	($15)	$85	$80
8%	$10	$130	$125	-10%	($9)	$71	$66
10%	$13	$138	$133	-3%	($2)	$64	$59
-15%	($21)	$112	$107	17%	$11	$70	$65
35%	$39	$146	$141	25%	$18	$83	$78
63%	$92	$234	$228	29%	$24	$102	$96
-2%	($5)	$224	$219	-10%	($10)	$86	$81
20%	$45	$264	$258	15%	$13	$94	$89
15%	$40	$298	$293	20%	$19	$108	$103
-10%	($30)	$263	$258	-2%	($2)	$101	$96
29%	$76	$334	$329	63%	$63	$159	$154
25%	$84	$413	$408	35%	$56	$210	$205
17%	$70	$478	$473	-15%	($31)	$173	$168
-3%	($14)	$459	$454	10%	$17	$186	$181
-10%	($46)	$408	$403	8%	$15	$195	$190
-15%	($61)	$342	$337	25%	$49	$239	$234
=============				========
192%	Mythical Total ROR	Actual Total Change in Account Value	237%	192%	Mythical Total ROR	Actual Total Change in Account Value	134%

12%	Mythical Average ROR	Actual Average Change in Account Value	15%	12%	Mythical Average ROR	Actual Average Change in Account Value	8%

If we reverse the order of our gains and losses, however, things change dramatically. Now, while I’m still not broke, my Actual Account Value has been reduced to only 8%.

But wait, there’s more!

Look at the final example. In this example my goal is to run out of money. It’s the, “I’m going to spend my last penny the day I die” example. Therefore, I’ve increased my withdrawals to $17. At the end of the term, I’m out of money, game over, game won! However, look what happens if I reverse the sequence of gains and losses. If I experience losses early in my withdrawal stage, my retirement stage, I’m broke in just 6 years!! You see, while the sequence of when you incur gains or losses is meaningless when you are in the accumulation phase, it becomes very meaningful in the withdrawal phase.

Initial Investment	$100
Withdrawal	($17)

% Gain/Loss	Amount Gain/Loss	Before	After	% Gain/Loss	Amount Gain/Loss	Before	After
25%	$25	$125	$108	-15%	($15)	$85	$68
8%	$10	$118	$100	-10%	($9)	$59	$42
10%	$12	$112	$94	-3%	($2)	$40	$22
-15%	($17)	$78	$60	17%	$7	$29	$12
35%	$27	$87	$70	25%	$7	$19	$1
63%	$55	$125	$107	29%	$5	$7	($11)
-2%	($2)	$105	$87	-10%	($1)	($11)	($29)
20%	$21	$108	$91	15%	($2)	($30)	($48)
15%	$16	$107	$89	20%	($6)	($54)	($72)
-10%	($11)	$79	$61	-2%	$1	($70)	($88)
29%	$23	$84	$67	63%	($44)	($132)	($150)
25%	$21	$88	$70	35%	($46)	($196)	($214)
17%	$15	$85	$68	-15%	$29	($184)	($202)
-3%	($3)	$65	$48	10%	($18)	($220)	($238)
-10%	($7)	$41	$24	8%	($18)	($255)	($273)
-15%	($6)	$17	$0	25%	($64)	($336)	($354)
============				========
192%	Mythical Total ROR	Actual Total Change in Account Value	-100%	192%	Mythical Total ROR	Actual Total Change in Account Value	-454%

12%	Mythical Average ROR	Actual Average Change in Account Value	-6%	12%	Mythical Average ROR	Actual Average Change in Account Value	-28%

What’s the main lesson to be learned? Well, aside from understanding The Regeneration Principle itself you can clearly see that strategies used to accumulate money will not work when you start to make withdrawals from your investments. Ultimately, what you will have available to spend and how long it will last depends on many elements:

- How much you withdraw

- When you withdraw it

- What kind of gains and losses you experience

- When you experience the gains and losses

- Finally, it depends on how long you live!!!

This is why I say that your retirement will cost you more than you think and that planning for your retirement is more complicated than you imagined. It’s not hopeless and it’s not impossible to design a plan that will work for you. It’s just not that easy and you will likely need some help. There is a Better, Smarter, Safer Way!

Remember, The Regeneration Principle states that it takes a multiple in gain to make up for a loss. Therefore, the biggest lesson to walk away with is this:

It’s more important to make safe, conservative returns on your investments over time and to PROTECT YOUR PRINCIPLE, than it is to attempt to earn large returns and put your principle at unnecessary risk of loss.

It’s a good life!