Learn How to Deal with Losses in the Stock Market
There's really no way around it. You're going to lose money at some point if you invest in stocks. It’s bound to happen sooner or later. In fact, it might have happened already and you didn't even realize it because losses can take several different forms.
In its simplest and perhaps most painful form, you buy a stock then watch the price go down and stay down. At some point, you decide to end the pain and sell it. This type of loss is called a capital loss because it involves an actual dollar amount.
You can use a capital loss to offset profits, called capital gains for tax purposes. But beyond that, they're just a painful investing lesson.
Another type of loss is less painful but still very real. You might have bought $10,000 of a hot growth stock and one year later, after some ups and downs, the stock is very close to what you paid for it.
You might be tempted to tell yourself, "Well, at least I didn’t lose anything." But that's not true. You tied up $10,000 of your money for a year and you received nothing in return. If you had bought a bank CD, it would have earned you at least a little bit of interest.
Every stock purchase begins with a measurement against a risk-free investment such as a U.S. Treasury note. Ask yourself how much more could you earn purchasing a particular stock with some additional risk compared to what you could have earned on a note with no risk.
When a stock goes nowhere or doesn’t even match the risk-free return of a bond, you're losing money. You lost the opportunity to invest your money in something that would have earned you a positive return over and above the risk-free return—and that is a true loss.
Missed Profit Losses
This type of loss results when you watch a stock make a significant run-up then fall back, something that can happen with more volatile stocks. Not many people are successful at calling the top or bottom of a market or a stock. You might feel that the money you could have made is lost money—money you would have had if you had just sold at the top.
Many investors sit tight and hope the stock will “recover” and regain the high, but that might never happen. Even if it does, too many investors hold on hoping for even greater profits only to see the stock retreat again. The best cure for this type of loss is to be happy with a reasonable profit and don’t try to squeeze every penny out of a stock, risking a retreat and a missed profit loss.
You can tell yourself that “It’s only a paper loss,” or “If I don’t sell, I haven’t lost anything,” but reality is if you make a mistake or something unforeseen happens, you have to decide what to do about it.
If you believe the company’s long-term prospects are still good, it might be a good time to add to your holdings. On the other hand, your paper loss becomes a lost opportunity if you believe this is where the stock is going to stay and you sit on that paper loss when you could have invested your money in something that earns you a profit instead.
Dealing With It
No one wants to suffer a loss of any kind, but don’t let your ego get in the way of making the right decision when it happens. The best course of action is often to cut your losses and move on to the next deal. But there are other ways to take a deep breath and move forward, too.
Review the decisions you made with a cold eye after some time has passed. Could you have done anything differently? Would you have lost less or perhaps nothing at all if you had acted differently? Try to learn from the experience.
Tighten your financial belt for a while if you must and if the loss is small enough that you can recoup it with a little discipline. Regain that money. Then try again, keeping in mind the things you learned for the next time the market gets shaky.
Keep the loss in context and don't take it personally. Remind yourself that a lot of other people out there took a hit just like you did—perhaps even more of a hit than you did. The loss doesn't define you, but it can make you a better investor if you handle it correctly.