Handling investment loss

Be honest – are you a “buy high, sell low” investor?

One of the most basic investing guidelines is to buy low and sell high, but investors so often end up doing the opposite. The reason is that they don’t know how to respond to the losses that are inevitable, unless you stick your money in guaranteed investment certificates or high-interest savings accounts.

Investor Education Fund (IEF) commissioned some research recently on investment risk and loss, which indicates that about 36% of investors flee to safety after a loss, either for a short time or permanently. I’d go so far as to say that this type of behaviour is the number one reason people are frustrated with their investing results.

Let’s be specific here and talk about losses sustained by a whole portfolio, and not a particular investment. An effectively diversified portfolio will very often have some components that are making money and others that aren’t. It’s the whole that matters.

IEF’s research found that 51% of investors do nothing when they lose money, which is actually not a bad thing. One of the most important investing lessons of the 2008-09 stock market crash is that doing nothing can work out fine. The S&P/TSX composite index was down 33% in 2008, if you include dividends and share price losses together. For the 10 years leading up to Jan. 31, 2014, however, the index was still up an annual 7.7%. That’s right in line with what you should expect from a long-term investment in stocks.

Now, what about the small minority of investors who are neither selling nor doing nothing following a loss? IEF’s research shows they responded to losses by buying more of their investments at a lower price. As personal finance columnist at the Globe and Mail, I’ve now seen two huge stock market sell-offs – in 2000-01 and 2008-09. I can tell you from experience that buying beaten-down investments when the markets are plunging is a smart move. They actually have a name for this strategy – buying low.

I did some buying in those two stock market crashes, and I wish I’d bought more. Why didn’t I? Fear of losing even more money, of course. So I get that you’re petrified in a falling stock market. My suggestion: If you can’t buy more of what’s falling, at least strive to do nothing. Assuming you have a well-built portfolio, the worst thing you can do is start selling things in a down market. Next you’ll be buying back what you sold after it has risen sharply in price – buying high after selling low, in other words. There’s no better formula for unhappy investing.

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