Recently, I found myself in the Financial Professional’s Twilight Zone when a client assured me, “It’s OK if I lose money. My investments are for the long term and the market always goes back up eventually.” Why was this client so carefree?
Some investors think that if they lose money on an investment, it doesn’t matter because they can hold on and make up their loss. They don’t realize that this is easier said than done. Earning back losses means both time and the market’s movement need to be on your side.
Why?
It’s a lot easier to lose money than it is to make money
Recovering your losses means the profit your investments generate needs to be greater than what you originally lost in percentage terms. To understand why this is the case, imagine you invest $100 and your investment drops in value, leaving you with $80. You just lost 20% of your money. To regain the $20 that you lost, however, you need to make 25% on your remaining funds. (This is because $20 is now one quarter of your total, rather than one-fifth of your original total.)
In addition to the difficulty of recouping lost money, think about what would happen if you need to use some of that money while your investment was “under water.” If you sell at a loss because you need to use the money, you won’t have the opportunity for the investment to recover its loss.
Prevention is the most effective solution
The best way to avoid the difficult position of recovering lost money is not to lose it in the first place.
While there is no such thing as a totally risk-free investment, you can lower the risk by diversifying your investments and investing in line with your personal risk tolerance. Before buying a stock, ask yourself, “How would I feel if I lost $[fill in dollar amount] with this investment? Would I/my spouse be able to sleep at night?”
To learn more about risk, read: profile-financial.com/reduce-risk
For more about what to do if you lose money in your portfolio, read here.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published April 2, 2018. Updated March 2020