In the world of investing and trading, loss is a concept many people are uncomfortable contemplating, and thus, there is comparatively less discussion and perspectives around how we should view loss – and subsequently recover from it.
In fact, to help shed more light on how traders and investors should handle loss, DollarsAndSense launched an entire content series dedicated to interviewing prominent traders and have them share about their first (and sometimes biggest) loss.
With market volatility up and economy down during this COVID-19 season, many investors would be seeing investment losses during this period. They would have heard advice telling them not to worry about, since these are just “paper losses” and are therefore not “real losses”.
But is that really true? Let’s find out.
What Is An Investment Loss?
If you can buy a stock today for less than what you initially paid for it, your investment lost value. By definition, you have an investment loss. Had you had kept it in cash, you could have bought the same stock today, and have some spare change left.
That loss is real, whether or not you decide to exit your position.
Some people have the mistaken thinking that if they don’t sell their stock, they haven’t really lost money. And they would hold on to a loser in hope (more than in expectation) that the stock will somehow recover in price.
Or they would double down on their losing investment, thinking that dollar-cost-averaging would even out their entry price, thus reducing their “paper loss”. But you should remember that buying cheaper later on doesn’t erase the fact that you did indeed lose money on your initial investment. Such thinking is mathematically wrong, and a bad basis for making investment decisions.
Do you now see how dangerous the concept of “paper loss” is?
What Can Investors Do When Their Investment Made A Loss?
It might sound harsh to say, but the best thing to do is to have a plan even before making your investment. That way, you won’t be reacting purely based on emotions, which is a common pitfall that investors, even seasoned ones, continue to grapple against.
You should set your overall investment goals, and be able to articulate how buying that particular stock or fund will help you achieve those goals. For example, if your purpose of buying a stock because you want to be a little more diversified, dumping the rest of your war chest into that stock just because its price plunged, doesn’t make a lot of sense.
When you decide to make an investment, wargame various scenarios and decide what you would do in those situations. When would you cut your losses? Under what situations will you be willing to dollar-cost-average and buy more of that counter? What happens when something really bad happens to the company?
Every time prices move significantly, it is time to re-evaluate both the external market conditions as well as your internal portfolio composition. Is your investment portfolio still equipped to help you achieve your investment objectives, given the new external conditions?
Once you do so, you’ll be able to decide if your current loss-making holdings are still valuable and worth keeping around, or if other stocks are now even more attractive and come with less downside that you might want to acquire instead. Remember, you can’t do anything about your losses already incurred, but you certainly can do something today to ensure you have the greatest returns in the future.
A Paper Loss Can Turn Into A Real Gain, Just Like A Paper Gain Can Turn Into A Real Loss
Just as we shouldn’t simply hold on to a losing stock with misplaced faith that it will turn for the better, the converse is also true. Stocks that show paper returns today, can have the potential to drop in value some time in the future.
Thus, we should also carry out a portfolio review when stocks show outsized returns as well and evaluate whether we should still keep them around, or cash out when the going’s good in order to plough the money into other companies with better growth potential for the future.
Over time, the more important metric to look at is the investment horizon that we set for ourselves. Short-term gain or losses doesn’t matter if we’re still on track based on our longer-term investment goals, and we’ll be able to achieve tangible, substantial growth in wealth without being distracted by short-term price fluctuations.
Ultimately, the score that matters is the final one when the last whistle is blown.
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