Investing in the financial markets is a way to build wealth over time. But it's not unusual to lose money in the short term. Investment values go up and down. Rather than run away if the value of your stock drops, investing takes patience. This can be hard for the novice to understand.
Here’s what you need to know about why people lose money in the market and how you can bounce back from a loss in your portfolio.
Ignoring Market Cycles and Global Events
People often lose money in the markets because they don’t understand economic and investment market cycles. Business and economic cycles expand and decline. The boom cycles are fueled by a growing economy, expanding job market, and other economic factors.
When inflation creeps up, prices rise, and GDP growth slows. In this case, the stock market can also decline in value.
Investment markets also rise and fall due to global events. On the first day of trading after 9/11 (September 17, 2001), the Dow fell 7.1%. At the time, it was the biggest one-day point loss in the index's history.
If you sold during the week following 9/11, your investments most likely would have lost money. But if you’d held fast and done nothing after the decline, you would have been rewarded. Within a month of the attacks, the Dow Jones Industrial Average, Nasdaq, and S&P 500 were back to where they had been before the attacks.
If you want to avoid losing money during a market-wide drop, your best bet is to sit tight and wait for your investments to rebound.
Letting Emotions Guide Decisions
People lose money in the markets because they let emotions—mainly fear and greed—drive their investing. Behavioral finance—the marriage of behavioral psychology and behavioral economics—explains why investors make poor decisions. Learn basic behavioral finance concepts, and master your emotions to avoid making rash moves that cost a lot over the long term.
For example, following the herd mentality is one of the worst behaviorial mistakes you can make. It plays out whenever you blindly go where most others are going. Herding in investing occurs when you let "the group" guide your choices. This leaves out the step of evaluating all current information and then choosing.
To avoid losing money in the markets, don’t follow the crowd, and don’t buy into overpriced assets. Instead, create a sensible investment plan, and follow it.
In the late 1990s, venture capitalists and individual investors poured money into internet "dot com" companies. This drove their values sky-high. Most of these companies lacked the basic financial stability that investors seek. The "dot coms" spent capital quickly on staffing and marketing with no clear path to ever making a profit, Afraid of missing out, investors continued to listen to the popular press and followed the herd with their investment dollars.
A glance at historical S&P 500 stock market returns shows how buying and selling with the herd can damage returns.
Looking to Get Rich Quick
Some people lose money in the markets because they think investing is a get-rich-quick scheme. You can quickly lose your investment dollars by employing penny stock or day-trading strategies.
The Dalbar study of investor behavior found that for 2018, the average investor underperformed the market as a whole for the 25th year in a row. For 2018, the S&P 500 retreated 4.38%, while the average investor lost 9.42%. The reasons are simple. Investors try to outsmart the markets with frequent buying and selling. This rarely yields superior gains.
The year 2020 was almost an exception, because markets dropped so quickly in the wake of the pandemic. Investors didn't panic, but they saw opportunity, the latest 2021 Dalbar study revealed. Still, the average equity fund investor underperformed the S&P 500 by 1.31% for 2000.
To avoid losing money in the markets, tune out the outlandish sales pitches and any promise of quick riches. Like the Tortoise and the Hare, a "slow and steady" strategy will win the race.
Frequently Asked Questions (FAQs)
Can you lose more than you invest in stocks?
Whether you can lose more than you invest depends on the type of trading you do. If you have a cash account, which is a brokerage account that requires you to pay for securities using cash, you can't lose more than you invest. If you trade with a margin account, which allows you to borrow money to purchase securities, you can lose more than you invested.
How do you know when to buy a stock?
Research can help you decide whether to buy a stock. Consider trends in a company's earnings, how it compares to similar companies, and the price-to-earnings (P/E) ratio. Timing the market is difficult, so it's best to focus on whether you want to own a share of the company you're considering rather than whether or not the stock will go up.
The Balance does not provide tax or investment advice or financial services. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.