How to Deal with Losses in the Stock Market

From Warren Buffet to Joe Schmoe down the street, there’s not a single investor on the planet who has never faced a loss in the stock market. Maybe it was early in their career, when they made a bad call and lost half of their portfolio. Perhaps they took a gamble on a new up-and-comer in the market and lost 20 bucks before they backed out. Large or small, investor, day trader, or broker, every investor has seen their portfolio take a hit at some point.

It’s important as an investor to know how to deal with losses when they occur. Panicking and shedding your portfolio during a market crash can actually lose you more money in the long run. If you’d held on for a few months while everyone else traded themselves silly, you could come out winning. However, you also have to know when to back out.

Qai Hack: Losses in the market aren’t easy to swallow. But knowing how to deal with them can make them less painful going down. The key is to focus on your long-term investment strategy, rather than your short-term financial panic.

TL;DR

There are several types of losses in the market, each with their own causes and drawbacks.

  • Capital losses occur when an investor sells a stock for less than they paid. These make up a large portion of the losses from the 2020 pandemic market.
  • Opportunity losses occur when investors tie up capital in investments that don’t produce gains instead of ones that generate returns. This means their money sits stagnant rather than growing.
  • Missed profit losses happen when investors hold onto growth stocks after they peak and fall, rather than selling at peak.
  • Paper losses occur when an investor takes a portfolio hit in theory but doesn’t cash in on their losses.

Losses in the market can be tough to swallow. And many investors turn to shedding their losing investments at the first sign of a downturn. However, that may not always be the best strategy. Study after study has shown that long-term value investing produces greater returns over a period of 20 years or more than short-term growth investing strategies.

This is also evident in studies that compare the investing strategies of men vs women. They show that women tend to take long-term, risk-averse approaches. This leads them to an average 0.4% advantage over their male counterparts in the long term.

To deal with losses in the market, there are a few strategies investors can employ, such as:

  • Working with a financial advisor
  • Analyzing your actions and reactions to financial news
  • Making better-informed decisions in the future
  • Continuing to invest even after a loss

Types of Losses in the Market

First, let’s start by covering the different ways you can lose in the market. It’s not all about what you currently have invested, after all. We’ll also tie in two of these losses to the 2020 pandemic market (briefly) to illustrate our firm belief. The long game produces returns, while the short game has a high propensity for losses or lower gains.

Capital Loss

Capital losses are the kind we all think of when we talk about taking a hit in our portfolio. These losses are relatively simple compared to some of the others. If you buy a stock, the price drops, and you sell at a loss, you’ve made a capital loss. (As opposed to a capital gain.) Let’s share an example.

Our investor, Investiwoman, purchases 10 shares of Stock A for $10 apiece, or $100 in total. She expects the company’s stock to increase in price over the next year, but instead share prices fall to $5 apiece. Eventually, after the market refuses to budge, Investiwoman decides to take a hit and sells her 10 shares at $5 apiece, for a total of $50. Not counting transaction fees, Investiwoman has taken a $50 capital loss on her original investment.

Capital losses make up a large portion of the losses many investors experienced during March of 2020. When stocks plummeted, some lost half or more of their portfolio’s value overnight. Selling at the time meant taking a huge loss, though many who sold consoled themselves with the idea that they got out before it was too late.

However, as the market is beginning to show, many who held onto their stocks are now seeing returns far greater than if they’d sold when the market crashed due to increasing share prices and a new normal for business operations.

Opportunity Loss

Opportunity losses can be more frustrating mentally, in part because you may not see them coming (as you sometimes will with a capital loss). The financial damage from these losses isn’t always clear, either – you may just be aware that you’ve missed an opportunity, rather than how much you’ve missed out on.

Let’s look to Investiwoman for another example.

This time, she decides to put $5,000 of her earnings into Stock B, which everyone is sure is going to skyrocket in the next six months. Though the time comes and goes, and nothing. At the end of a year, she realizes that the stock hasn’t budged an inch. While she didn’t lose money, she didn’t make any either. And she may have had she invested elsewhere.

Opportunity losses also presented in the 2020 pandemic market. These came about in two ways. Some investors left their money tied up in the market to avoid taking a huge hit on their current portfolio. However, because they may not have had the capital to purchase new investments, they lost out on buying securities at their lowest.

On the other hand, some investors decided that the market was too shaky and didn’t invest capital available at their fingertips. While the market is inherently risky and many businesses feared going under, the market proved that investing at the lowest prices was often the smartest decision. Soon after the market crashed, many individual companies and even whole sectors (look at you, online technology) skyrocketed far beyond projected returns for the year. Any investor who didn’t jump on board at the time missed out on a huge opportunity for gains.

Missed Profit Loss

Missed profit losses occur when investors hold on too long after a financial high in the hopes that their investment will continue to climb. This is common in volatile stocks, such as those found in the technology sector, but can be found in more stable stocks as well.

Investiwoman is at it again. This time, she invests $500 in Promising Stock C. The stock climbs and climbs until Investiwoman’s stake in the company is worth over $1,000. And then, the stock drops suddenly, bringing her investment to about $800. That $200 difference is Investiwoman’s missed profit loss.

With missed profit losses, many investors decide to wait out the drop in the hopes that the stock will rise again. Sometimes it overshoots its original highs. Other times it doesn’t gain much at all. And sometimes it makes incremental gains, but never quite peaks again. Whatever the situation, the best way to mitigate the risk of a missed profit loss is to be prepared to exit the investment upon predetermined financial indicators.

Qai Hack: Timing the market is a risky strategy that can lead to financial losses beyond market performance. Instead of risking your financial future, build a solid plan for when to buy and sell – and stick with it.

Paper Loss

Paper losses in the stock market occur when an investor doesn’t sell a losing position in the market because “it’s only a loss on paper.” The thinking often goes that if you don’t sell a falling stock, you haven’t lost any money yet, because you haven’t cashed in your shares. In reality, if you’ve made a loss on paper, you’ve made a loss in your pocket, at least theoretically.

Paper losses are the kinds of losses that show an investor’s true strategy. Value investors, such as Warren Buffet, often brush aside paper losses in favor of long-term strategies that produce gains – but this only works if the company is worth it in the long run.

The danger with paper losses is that if a company is not a value company, the stock price may not increase for years to come (or ever). If this is the case, your paper loss just became an opportunity loss, as you’re tying up your money in a security that may never grant positive returns.

A Word from Qai: If you’re a value investor, it’s important to decide whether – and how long – you can afford to tie up your money in a losing security. Even Warren Buffet knows that sometimes, a loss is actually a loss – such as when he dumped all of his airline stock after the 2020 pandemic market crushed the industry.

How to Deal with Losses in the Market

Suffering a loss in the market can be panic inducing, but the most important thing is to not lose your head. While many investors believe that the best thing to do is cut your losses and find the next best thing, that’s not always the most fiscally responsible move.

In fact, study after study has shown that in the long run, value (buy and hold) investing strategies lead to the largest returns over a period of twenty years or more. While things may seem bad right now with losses in the stock market, keeping your mind on the long game can help shape a more positive perspective on your losses.

To illustrate, we’re going to discuss a few statistics, as well as the pandemic market of March 2020. While the market crash was obviously a major outlier in terms of market performance, it’s a good way to explain why investing for the long game – and not selling at the first sign of a crash – is actually the most beneficial move you can make.

Statistics in a Panicked Market

First, let’s examine some key differences between male and female investors in the 2008-2009 financial crisis. While that market is not necessarily identical to the pandemic market of 2020, the data shows a very compelling picture that may help us understand the market’s response to coronavirus.

For instance, a study from the mutual fund company Vanguard revealed that, during the aforementioned crisis:

  • Men were much more likely to sell at market lows
  • Males were 50% more likely to trade, period – often at the wrong times
  • Men are more likely to sell after the market falls and buy as stocks begin to rise
  • Women are more likely to sell before the market falls and buy in the midst of the crash (or hold their positions throughout)
  • Men were more likely to move on short-term financial news
  • Men were more likely to invest in high-risk securities, such as stocks
  • Women were more likely to take a risk-averse approach (typically via fixed income investments or real estate)

Overall, the Vanguard study found that female investors were much more likely to turn a profit simply by holding their investments or only selling when they had to, rather than on first sight of a major market crash.

Why the Female Advantage?

A knee-jerk reaction may be to assume that these statistics come in light of a crisis market, which is not always indicative of the long-term market trends. However, a 2017 study from Fidelity backed these claims in a non-crisis environment.

For instance, Fidelity found that that, on average, women outperform men by 0.4% over the course of their lifetime. Year to year returns find that female investors beat their male counterparts’ returns by about 1% annually.

Another study by Fidelity found that women tend to outperform men by about 40 basis points per year. Furthermore, in a non-crisis market, Fidelity found that men are 35% more likely to buy and sell (typically, but not always, based on short-term financial news) compared to women. Moreover, studies have found that men in relationships with women are less likely to trade if they share an account with their female partner.

There are a lot of theories and even a subset of psychology dedicated to understanding why investors make the decisions they do. While no one theory is necessarily right, the overarching theme is that men are much more likely to take risks, move on sudden news, and invest in short-term strategies. On the other hand, women are much more risk averse as a rule and look to long-term financial comfort rather than moving on today’s events.

It’s worth noting here that part of the reason men see lower returns on average is due to their higher costs of trading. While some of the losses certainly come from the poor performance of high-risk investments, some of the loss can be attributed to the fees associated with buying and selling positions more frequently. Men who hold their positions similarly to female investors are more likely to see similar returns as their female counterparts. 

So…How Do I Deal with My Losses?

Male or female, the answer frequently comes out to: look to the long game. The market is fickle and trades up or down based on the news cycle. A single event can skyrocket a stock’s share price or send it cratering through the Earth’s crust. Instead of trading positions on every tick up or down in the market, consider the investment carefully and with a critical eye.

There are times when massive losses in the stock market are worth selling for. Legendary investor Warren Buffet, who is notorious for his “buy and hold” value investing strategy even when it may not make sense to the rest of us, sold his airlines shares after the pandemic market of 2020. While he certainly took a large loss on his decision, in the end, it may turn out to be the right one – especially if airline shares continue to tank and the issuing companies buckle under the pressure.

While we can’t tell you whether buying or selling a certain stock is always the right decision for you, we can provide you with a few tips to help deal with your losses in the stock market and make these decisions on your own.

Quick Tips

  • Talk to a financial advisor. Not everyone feels they need one, but many times, a financial advisor’s primary job (aside from buying and selling shares) is to calm down clients in the midst of panic markets and losses in the stock market.
  • Analyze your positions. Whether or not you hold your positions beyond their initial crash, examine your decisions after some time has passed. If you sold your positions, would you have made more money in the long run by holding and pretending the crash wasn’t happening for the sake of your mental health? Alternatively, if you held your positions and are now questioning whether that was the right move, would selling earlier have made you more or less money than selling now, after the dust has settled?
  • Evaluate and make better decisions. If the problem isn’t a pandemic market, but in fact the securities you invested in, look at where you went wrong. Do you need to change your investing strategy? Did you make one poor choice on the promise of “the next big growth stock”? Does the stock still have a chance to rise, or is it best to get out now before you lose harder? (A financial advisor may be able to help with these decisions if you’re unsure).
  • Keep investing. It’s important not to lose your confidence over a bad call or an unprecedented global pandemic that shatters the markets. You’re not the first investor to take a hit and face losses in the stock market, and you certainly won’t be the last. Use the experience as a (painful) learning opportunity to better your strategy and financial position in the long run.

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