“Be strong” – every investor to the stock market rn
(Stock Market Losses)
September 4, 2020 by The Q.ai Team
The educational portion of this newsletter focuses on stock market losses
Can you believe it’s already September? We can’t decide whether this [meh] year has gone by extremely fast, or if the concept of time itself has become obsolete. Anyways, we thought we’d share the biggest names in the stonk market – because, ya know, ~*camaraderie*~
Biggest headlines of the week
- Tesla and Apple stock split went into effect on Monday. Following Tesla’s 5-to-1 split and Apple’s 4-to-1 split, the buying spree added $50 billion and $70 billion in market cap, respectively. When a company decides to split, that raises the number of shares available and lowers the cost of a single share. This makes purchasing stocks more accessible for investors with less capital. It also indicates that the cost per share could increase, which can spur an upswing in purchases. That is exactly what happened, which is why many argue Tesla and Apple stocks are currently overvalued. And given neither have released new products to warrant the surge seen on Monday, a massive sell-off is inevitable. Read more.
- Speaking of massive sell-off… Thursday was an absolute “bloodbath” for the stock market, as many headlines strangely stated, verbatim. How bad was it really? It was the worst-ever one-day decline for the Nasdaq since hitting a record high just one day before. It was the worst day for tech since the start of COVID. No major index ended the day in the green.
- Robinhood might have to pay the SEC a fine of at least $10 million. This is due to it not disclosing its practice of selling client order flow to high-speed trading firms, one of the company’s revenue streams. Read more.
- The Justice Department shared plans to file antitrust charges against Google. This could happen as soon as this month and focuses on its dominance in search – Google controls 90% of all web searches globally – and its control over online advertising. Read more.
- Honda and General Motors (GM) joins forces. The automobile industry has felt the pain of a seemingly indefinite recession that has plagued the global economy. And while this deal helps lower overall costs, the deal was struck as a way to produce EVs and lower emissions for cars, something the industry as a whole has felt immense pressure for. Read more.
Are we living through another September Effect?
September is often referred to as the worst month for the stock market, or the “September Effect.” There is no rhyme or reason – just data to back up the existence of this anomaly. At first, it almost seemed as of this year would be the exception – and it very well could still be (it’s only day 4). But history repeats itself. Since 1950, the month of September has seen an average decline of:0.8% in the Dow Jones Industrial Average (DJIA)0.5% in the S&P 5000.5% in the Nasdaq (note: the Nasdaq was established in 1971)Many hypothesize it’s due to the end of year coming up, an opportune time to review holdings and rebalance portfolios. Others suggest that it’s because big-time investors are returning from summer holidays and are shedding the securities they have been planning to sell regardless. The latter seems unlikely this year, all things considered.
Why does this matter?
To be honest, it kinda doesn’t… But something to consider: August is famously a strong month for the stock market. And during election years, September and October are especially weak – so the bar is set pretty high for this year in particular. According to the LPL, “the S&P 500 returned an average decline of -0.2% in September and -0.7% in October during election years.”
Given what we know, despite everything we’re seeing in the news regarding stock market performance, if there’s anything an investor should not do over the next few months it is to sell out of fear of further stock market losses. This theme will continue to be a focus for the remainder of this newsletter. We hope you do the right thing (and hold!).
How to take stock market losses in the stock market like a champ
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, as 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. There are several types of losses in the market, each with their own causes and drawbacks. To deal with losses in the market, there are a few strategies investors can employ, such as continuing to invest even after a loss and analyzing your actions and reactions to financial news.
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 small 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 one point in time. It’s important as an investor to know how to deal with losses when they occur. Panicking and shedding your portfolio during a massive market crash can actually mean you lose more money in the long run, rather than if you’d held on for a few months while everyone else traded themselves silly. However, you also have to know when to back out.
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 their relation 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 losses occur when an investor sells a stock for less than they paid. Simply put, if you buy a stock, the price goes down, and you sell at a loss, you have 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.
An example, IRL
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, after a few months went by, many who held onto their stocks are now seeing returns far greater than if they’d sold when the market crashed.
Opportunity losses occur when an investor ties up their capital in an investment that doesn’t produce gains instead of an investment that generates returns. This means their money sits stagnant rather than growing.
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.
An example, IRL
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. Any investor who didn’t jump on board at the time missed out on a huge opportunity for gains – thus, their opportunity loss.
Missed Profit Loss
Missed profit losses occur when investors hold on to a growth stock after it hits its prime and begins to fall again, rather than selling at its peak. 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. However, the best way to mitigate the risk of a missed profit loss is to be prepared to exit the investment upon predetermined financial indicators.
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 losses occur when an investor takes a portfolio hit in theory but doesn’t cash in on their losses 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. 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 Q.ai
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.
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 Vanguard revealed that:Men were 50% more likely to trade, period – often at the wrong timesMen are more likely to sell after the market falls and buy as stocks begin to riseWomen 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 newsMen were more likely to invest in high-risk securities, such as stocksWomen 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:On average, women outperform men by 0.4% over the course of their lifetimeYear to year returns find that female investors beat their male counterparts’ returns by about 1% annuallyWomen tend to outperform men by about 40 basis points per yearIn a non-crisis market, men are 35% more likely to buy and sell (typically, but not always, based on short-term financial news) compared to womenMen 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. 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 and make these decisions on your own.
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?
Lumbergh is in luck – the Stock Market will be closed on Monday for LDW
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?
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.
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 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.
The Bottom Line?
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.
The Little Book of Common Sense Investing is one of many books available that details how to be a smart investor. Originally published in 2007, the tenth anniversary edition includes updated data and new information, but focuses on the same core concepts: long-term buy and hold strategies with an emphasis on index funds, such as the S&P 500. Written by the founder of The Vanguard Guard, this book is great for investors of all literacy levels and has been lauded as one of the best finance books out there