This massive crash in the stock markets has had us all worrying. Almost every single investor is suffering a loss in the markets at these levels. Unfortunately, the truth is there is no way around it. If you invest in stocks, at some point you are likely to lose money.
You have to accept that volatility is a part of stock markets. Business cycles are a reality. And extraordinary events like these will only give rise to market volatility.
This can result in more loses which come in different forms: realized or unrealized. Over longer periods or short.
These different types of losses are best explained with an example.
Assume that you buy a stock of ABC Ltd.
Over time, the stock price of ABC Ltd. crumbles. But you wait to justify your purchase and then eventually make the tough call of selling it. Thereby actualising a real loss referred to as CAPITAL LOSS. As you are selling a capital asset for less than its purchase price.
For tax purposes, a short-term capital loss is defined as a loss realized within a year of purchase and long-term is more than a year.
You chose to buy ABC Ltd. but there was another stock XYZ Ltd. available as well. Now ABC didn’t do well (5% return) but XYZ Ltd. did (40% return). Technically, you didn’t lose any actual money. But had you chosen XYZ Ltd. your money would have grown a lot more. This kind of a loss is referred to as an OPPORTUNITY LOSS. Although it isn’t something you realise but it’s very much real and painful.
Assume ABC Ltd.’s value falls overtime but you still believe in its prospects and decide not to sell. So in your books it’s an UNREALISED LOSS. A loss that hasn’t been actualised.
While it's only a loss on paper, the reality is that if your investment has taken a major hit. Now, this can be due to a market-specific or stock-specific issue. Either way, you need to look into it and form a plan of action. As ideally, any kind of strong movements in your choice of investments should alert you.
How to deal with the losses
There is no doubt that each of these types of losses can be painful. But you can mitigate the sting with the right mindset and a willingness to learn from the situation.
Analyse your choices: reviewing your decisions with a new fresh mindset is important. Look at the situation differently and preferably without any biases. The key here is to learn from your mistakes and move forward. If you think the initial reason you invested in the stock doesn’t hold cut your losses and get out. There is plenty of other fish in the sea that can help recoup your losses.
Consider recovering what you lost: practice frugality for a while. Try to cut down on certain costs until you can recoup the lost amount. Spend less on eating out and entertainment (it is known to be the area where people tend to overspend). The idea is to trick your mind into settling the loss and move on. Recover that money and invest again, keeping in mind the lessons for the next time the market gets shaky.
Don’t allow the loses to define you as an investor: 1-2 bad choice of investments doesn’t make you a bad investor. Keep in mind that no investor gets it right the first time or even makes a large profit in every stock they chose. They don’t let that affect them negatively. Instead, they learn from their mistakes and emerge as better investors.
Even the most successful investors suffer losses at some point in time. As there is no sure shot strategy that works endlessly at all times in the stock markets. Mainly because of the various external factors that can come into play at any point in time.
As difficult as accepting losses is long-term investors need to accept stock markets volatility. Business cycles are a reality. And extraordinary events like these will give rise to market volatility.
The key is to define an investment strategy, a good investment plan that will help you in good times and bad. And stick to it.