Why the 30 Percent Stock Market Rally Isn't Really 30 Percent

There's a lot of buzz in the media lately about the stock market's 30 percent rally off its March lows. Don't get me wrong, I'm happy things are up and looking better. But that 30 percent return isn't all it's cracked up to be.

Because of the big declines over the last 18 months, the 30 percent rally has only returned about 13 percent of what the stock market was worth back in October 2007.

Here's how it works.

• Assume you have $100 in your account and it declines to $45. That decline represents the roughly 55 percent decline the stock market had between its high in October 2007 and its recent low in March 2009.
• Now assume you earn a 30 percent return on that $45. This puts your account value at $58. That's $13 more than you had at the bottom, or 13 percent of your original $100 account value.
• At this point, you'd need about a 120 percent return off the March lows for your investments to regain their October 2007 value.

You see, when markets, or individual stocks, are coming off huge declines, the initial big percentage moves don't carry a lot of economic weight because the values have been so depressed.

For instance, many banking stocks are still down 80 percent from their highs in 2007. And these stocks have been some of the biggest percentage gainers over the last month. But if you own something that was worth $100 and it fell to $10, a 100 percent return on $10 only gets you back to $20, or 80 percent less than what you started with.

Yet those big percentage returns can be seductive. Investors start to think they can make big money if they can time these moves. Or they think they need to rush back in before they miss out on an opportunity to repair their damaged portfolios.

Well, when you have this much volatility, it generally means there's lots of speculation in the market. And as quickly as it moved up, it can move down, especially when dealing with bounces off huge declines.

Bottom line: These eye-popping percentage moves aren't as big a deal as they might appear. And if you try to chase these numbers, you may end up doing yourself more damage. The highest probability approach is to sit tight with a diversified portfolio of stocks. When the markets make a meaningful recovery, you'll participate.

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