You worked hard for your money. Perhaps you put in long hours at the office to earn it. Maybe you increased your savings by scrimping in areas you normally would not. No matter how you received or retained your cash – it’s yours! One day you decide to put your surplus funds into an investment – say some stocks or bonds – and then you sit back and hope to achieve a healthy return, right? What happens when you don’t though? How do you feel when things turn sour and you end up with an investment loss?
I can tell you from recent experience it’s an awful feeling watching an investment loss unfold right before your eyes. Seeing your hard earned money essentially vanish is the stuff from which nightmares are made! Fret not, though, because there are ways to deal with the emotional toll an investment loss elicits.
Investment Loss: Realized vs. Unrealized
First off, I must point out the difference between a “realized” loss and an “unrealized” or “paper” loss. You may already be familiar with these terms, but, in case you are not, let’s take a brief second to review. When you buy your investment the purchase price becomes your cost basis. For instance, let’s say you bought one share of IBM for $100 on Day A. On Day B, the market price for the one share drops to $95. In that instance, you have an unrealized loss of $5. In other words, it hasn’t been locked in yet because on Day C, the market price could move to $102 at which point you would have an unrealized gain of $2. Now, if you actually sold your stock on Day B at $95, then you would have a realized investment loss of $5. Once you dispose of the investment asset, you essentially lock everything in place and it becomes realized. The example given here is very simplified, but it illustrates the basic concept.
Mr. Utopia’s Recent Investment Loss
If you’ve had a chance to read my story about how my wife and I paid off $140k of debt in less than 3 years, you’ll know we were down to our last few dollars about 1.5 years ago. Since then, we’ve been saving feverishly to restock our emergency funds as well as to lay the foundation for possibly our next goal – to purchase a home. We had the money sitting in a “high yield” online savings account that was yielding anything but high returns. Wanting to put our money to better use, I started exploring a higher yielding but still fairly conservative investment option. After doing some research, I settled on the municipal bond mutual fund Vanguard California Long-Term Tax Exempt (VCITX) and moved a vast majority of our money there in early April. It made solid sense at the time:
- The fund pays monthly dividends at a higher rate than our online savings account
- The dividends are tax-free at both the Federal and state level (we’re California residents)
- I anticipated the fund price to be stable because interest rates seemed fairly steady at the time; the Fed (Ben Bernanke) said long term interest rates would remain roughly where they were through 2015 (note, bond prices fall when interest rates rise and vice versa)
Except, what actually happened about a month later was Bernanke and the Fed started hinting at phasing out QE (quantitative easing). As a result, the market panicked and long-term interest rates started spiking upward (this is also the reason you’ve recently heard all the talk about mortgage rates rising). Through the latter half of May and into June I watched as the price of VCITX continued to drop. I held on for a little while thinking perhaps this was just a blip in the market and things would calm back down. However, amid all the remaining uncertainty, I decided the risk was just too great to hold the fund any longer and on June 14th I sold locking in and realizing a loss. In the end, we lost $746 in a little over 2 months. It was a tough blow to take knowing that it set us back from our financial goals. Dealing with the negative emotions associated with this experience was tough. Below I’ve listed some ways that helped me put things in perspective.
How to Cope With an Investment Loss
- Everyone Strikes Out: Don’t beat yourself up over an investment loss. Yes, it’s unfortunate. However, take a step back and realize no one is perfect. Even the best and most famous investors, take Warren Buffet for instance, has losers every now and then. As long as you did your due diligence ahead of time then don’t go overboard berating yourself. Keep your chin up and have faith that you’ll do better next time.
- Tax Implications: There’s a silver lining when you incur investment losses – you get a tax break! For tax purposes, an investment loss is called a “capital loss” (and a gain is a “capital gain”). When you incur a capital loss, you are able to use that loss to reduce your overall tax bill by either netting the losses against capital gains and/or possibly against your gross income. I won’t get into the finer details of all the IRS rules because, as always with anything tax related, it can get complicated. However, just take some comfort in knowing an investment loss does have a “consolation prize” by potentially lowering your overall tax bill.
- It Could be Worse: As bad as the investment loss may be, realize it could always be worse. In my shared example above, the price of VCITX continued to tumble. So, if I had held on to the fund longer than I did, I’d be facing even greater losses. The point here isn’t to dwell on a worst case scenario, but rather to acknowledge perhaps you are fortunate the outcome wasn’t even more dire.
- Learn Lessons: Do your best to view the investment loss experience as a learning opportunity. Sometimes making a mistake is more beneficial than getting it right. By this I mean you might be incentivized to study where you went wrong and, in the process, become much more knowledgeable overall. Lessons to be learned might include:
- More or Better Research – Could you have done more or better research before you initially made your investment? What could you have done differently in the decision making process? Did you miss available information that could have resulted in investing your money elsewhere? Did you actually find that information but ignore it? Ask yourself questions like these not to beat yourself up over the investment loss, but rather to learn so you can make more informed decisions next time.
- Knowing Your Situation – Be aware of your personal situation. What is your goal? Are you investing for retirement? A child’s college fund? To save for a home purchase next year? Being cognizant of your specific situation should very much dictate how you invest. If you suffered a realized investment loss, then it’s quite possible you didn’t appropriately contemplate your unique situation and invest accordingly.
- Investment Horizon – This is a factor that many people seem to often ignore – how long do you plan to keep your investment? If it’s a shorter term because you might need the funds soon for another purpose, then you should make your investment in more conservative assets. On the other hand, if you are looking at a longer term horizon, then a more aggressive investment vehicle may be appropriate (because it allows for more time to recover from unrealized losses).
How about you – did you experience an investment loss? Did it cause some emotional distress and, if so, how did you overcome those feelings?