Thinking About Investing in the Stock Market? Be Prepared to Face Losses
Investing in stocks is one of the surest ways of accumulating wealth. Yet, almost half of the U.S. adult population avoid stocks like you avoid a rattlesnake. This fear is entirely rational; the stock market is notoriously volatile. And if you work hard to earn a living like most people do, losing your hard-earned money is the last thing you’ll want to risk.
If you watch the current financial news, the stock market just had its worst week in two years. It’s scary!
However, losing your money in the stock market is literarily inevitable. If you invest in stocks, you will lose money at some point. You can’t avoid it. And because losses come in different guises, this might have already happened without your knowledge.
Let’s take a look at how one can lose money in the stock market? Losses in the stock market come in different forms. Let’s break them down as simply as possible so you have an idea of what you may have to deal with.
Capital loss happens when you buy a stock and watch, teary eye, as the price goes south faster than a scalded dog and remain there, unmovable. At some point, you may decide to have mercy on yourself and end the pain by selling it off. You lose actual dollars, hence the term capital loss.
Although not as painful as a capital loss, lost opportunities is another significant type of loss possible in the stock market. Let’s say you bought $5,000 of a hot growth stock, and after a year, after some ups and downs, the stock has remained close to the initial value. On the surface, it seems you haven’t lost anything. But look deeper; you’ll find that you just tied down your money for a whole year without earning anything on it.
Even a risk-free bank CD or a government bond will have earned you some little interest at the same time.
Each stock purchase is measured against a risk-free investment such as a government bond. You ought to determine how much could make by buying a particular stock with risks against what you could have made with a government bond without risk.
When a stock, like the pyramids at Giza, goes nowhere or doesn’t even match the earnings on a risk-free bond, you’re making a loss. You lost the opportunity to put your money into something that could have given you a positive return above the risk-free return.
Missed Profit Losses
This type of loss happens when a stock makes a considerable run-up then plunges. It’s usually more common with volatile stocks. Calling the top or bottom of a market can be tricky, and very few people can successfully pull that off. Consequently, you feel that the money you could have made had you sold at the top is now lost.
Now, some investors sit tight and hope the stock will “bounce back” and reclaim its giddy heights, but that might not happen. Even if it does go up, some investors hold on with the hope of even higher profits only to see the stock fall again.
The remedy for this type of loss is to be content with a reasonable profit.
Trying to milk every penny out of a stock can open you up to the risk of a retreat and a missed profit loss.
This type of loss is also known as an unrealized loss. It occurs when the value of a stock drops below its original price, but you haven’t sold the investment yet. You can convince yourself that it’s only a loss on paper or that if you don’t sell, you haven’t really lost anything.
But to get out of an investing mess, you must make a move. When the unexpected happens, or you made a mistake, you’ll have to deal with it decisively.
If you think the company has good long-term prospects, this might be a good time to increase your holdings. On the contrary, if you believe that the stock will remain, immovable like a rock, on its present value, your paper loss then becomes a lost opportunity because you could have invested your money in something else that would have earned you some profit.
What do you do when you lose money in the stock market?
Losing is never fun for anyone. But when shit hits the fan, you have to make the right decisions without letting your ego stand in your way.
Usually, your best line of action is to cut your losses and move on. However, there are some things you need to do that will help you deal with the loss and move forward.
After some time, critically review the decisions you made. Is there anything you could have done differently?
Will it have yielded a different result? Will the loss be less or no loss at all had you acted differently?
Look for lessons in the experience and grow from it.
You can set about recovering the lost money by tightening your financial belt, especially if the loss is small enough to be recovered by a little discipline. Then with all the valuable lessons you’ve gleaned from the experience, pull yourself together and try again.
Don’t take the loss as personal. Of course, you weren’t the only one hit, and some people even had it worse. The loss is not an indictment of your business acumen or skills. But it can help you become a better investor if you heed the lessons therein.
Investing Mistakes to Avoid to Minimize Losses
Investing in the stock market certainly carries some risk as well as gain. For each investment, you must weigh the potential reward against the risk to see if it’s worth it.
While you may face losses at some point in time, here are some investing mistakes to avoid to keep you from burning your fingers badly.
Being overly reactive
Do not panic and sell off your position once the stock market takes a tumble. This is a sure way to lose your money. Mind you, when your portfolio drops, your loss is still on paper and only becomes a real financial loss when you sell.
Once the market plunges, stay calm and maintain your strategy. Typically, the market will not only recover but could even rise higher than the previous highs.
Although it may be nice to make a quick buck in the market, investing and getting out quickly makes it more likely for you to lose. This is because the market frequently experiences corrections (periods when values decline by 10 percent or more) and if your exit happens to coincide with one of them, you will surely lose money.
However, the stock market has always recovered from each correction. Therefore, if you are patient and opt to invest for the long haul, you are more likely to gain.
Not diversifying your portfolio
Investing in the stock market is about maintaining a diversified stock portfolio which will help protect your investments from sector-specific fluctuations. On the other hand, putting all your money in one sector or buying only individual stock will set you up for massive losses when that sector goes down.
Buying plenty of penny stocks
Penny stocks are those with a value of $5 or less. Because of their small value, they may seem to be safe investments. But the problem with penny stocks is that they are issued by smaller companies who do not trade on a public exchange. You can’t get enough information about the underlying companies, and since they are not subject to the same requirement as companies that trade publicly, your investment is less protected from losses.
In conclusion, the best investment strategy when it comes to investing in the stock market is quite simple: buy an assortment of high-quality stocks and hold them till you reach your investment goals – even if it takes years.