- OUR VIEW
- LEARNING CENTER
One of the hardest aspects of investing is losing money. But there isn't any way to avoid it. Stick around long enough, take enough positions, and you will lose money. Plus, there are multiple ways to lose. How you deal with loss is important.
Capital loss is what most people think of when they ponder "losses."
Capital loss, of course, is selling something for less than what you paid. As the opposite of capital gains, everyone understands capital loss.
If you have a diversified portfolio, you will have losses in one or more of your positions. It is inevitable. No long-term investor with a significant size portfolio has had 100% winning positions forever. It just doesn't happen.
But capital losses aren't the only type of losses.
For example, many people with "paper losses" sit around waiting for the stock to rise back to "what they paid" in order to avoid loss. Often this poorly thought out strategy leads to even greater capital losses.
But even when the stock price does return to the purchase level, the opportunity cost loss may be even greater.
Opportunity cost loss is what you give up by not taking a particular path. For example, if you uncover a particularly appealing stock, but fail to invest, and the stock starts to rise, you have "lost" the money you might have made had you acted sooner.
If you let opportunity cost bother you, it often leads to greater opportunity cost loss. After all, most great stock runs start somewhere. If you insist on entering only at the lowest point on the chart, you will never make money.
Don't let the feeling of opportunity cost loss prevent you from taking action.
Another common type of opportunity cost loss is when you discover a new investment opportunity, but you don't have cash. In this situation, you have to compare your new possibility with all of your existing investments. If the new opportunity presents a greater risk/reward ratio, you should sell some current holdings to pay for the new positions. Otherwise, your "loss" will be the difference between what you make on your current investment, and what you might have gained on the new position.
You have to be unconcerned about opportunity cost loss.
Take action. Delay is costly.
"Time is money."
Truer words were never spoken. Time value loss is just as real as other types of loss.
A common example is holding a bond that has been called, but failing to send the bond in to be redeemed. Called bonds stop earning interest the day they are called.
The failure to reallocate money such as redeemed money is as real a "loss" as other types of loss. It is harder to calculate the value of the loss, but it is a loss just the same. "Parking money" simply because you haven't thought about what to do with it, usually equates to time value loss. If you sit on money for three months, you have lost the difference between money market rates and CD rates while procrastinating.
You must make a conscious decision for your capital.
This common type of loss comes from failing to picture your entire portfolio as a single object. While focusing all of your attention on the 10% of money you have in stocks, the 90% position you have in cash overwhelms your total return. Even if you pick great stocks, the asset allocation decision is the single most important.
A 50% return on a stock that represents 10% of your investable assets, with everything else in cash, is hardly great wealth management. You may boast about your great stock picking, but the person who chose an 80% allocation towards stocks that rose just 10%, had a greater total monetary return than you. With a lot less risk. (Assumes 4% return on cash.)
Look at the big picture.
Perhaps the most common form of loss is "paper loss," or unrealized losses. "I haven't lost anything until I sell," is the mantra most people quote when faced with paper losses.
The problem with paper loss is that they force most people into denial. Rather than coming up with a new reason to hold the stock, at its lower price, they start hoping it will rise.
What paper losses should really do is force you into a reexamination of why you own a stock. There are only three possible decisions when you reexamine a position with paper losses.
Paper losses should force you to "reexamine your original premise." This assumes, of course, that you had a rational premise for owning the stock in the first place.
Make sure you know why you own a stock. It is the only way to handle paper losses.
Many people hold stocks that are higher than their purchase price, but far off the highest price the stock has reached. Some people look at the difference between what they might have, if they sold at the high, and what they have now, as lost money.
If you do this, it is an indication that volatility bothers you. You need to be comfortable with volatile stocks in order to hold them. And this means being comfortable with "off the high losses" during your holding period.
You may never recover "off the high losses."
If you invest long enough, you will encounter all of these types of losses. If you let loss paralyze you, you'll never succeed in the markets.
The best approach, we feel, is continual and constant addition of new money, from your income stream, to your investment assets. It's the traditional approach of a "savings" plan.
A disciplined savings approach, with a viewpoint of your entire portfolio and not just your stocks, will allow you to eventually overcome any of the above losses, and keep going.
Investing is a double edged sword, and to succeed over the long term, you need to withstand losses over time. Withdrawing from the market is the only way to guarantee that your losses are permanent.
Robert V. Green