Losing money is painful, but it is unavoidable.
During a market crash it is almost impossible for any investor not to loss money. What you can do is to learn how to deal with the loss and move on.
Unexpected events such as the trade war between China and United States in 2019, Coronavirus (Covid-19) in 2020 can cause the stock market to plunge more than 10% in just a day.
Market loss can comes in 2 ways:
- Immediate: The loss is clear, where the stock price plummets down like no tomorrow.
- Slow: The loss can be subtle, where the stock slowly but gradually drop in price over a period of time.
Losses can also come in different forms. There are 4 different types of market loss which are most common and we should learn from these painful lesson to become a better investor in the future.
With the right mindset and a heart willing to learn, we shall learn how to deal with these loss in the stock market.
How to prepare for market crash by age
1. Paper Loss
“If I don’t sell, I don’t loss anything,” or, “it is just a paper loss, it will be alright.”
Does these sounds familiar in anyway?
Yes, most investor believe that if they don’t sell their stocks, it is just a paper loss. If they don’t sell, the loss won’t be ‘realized’, thus ‘no loss’.
But in reality, if you have made a mistake or something unexpected have happened to your stock. You have to decided what is your next course of actions.
Investor can perform 3 types of actions:
- Sell and cut losses
- Buy more at a low price
- Do nothing, wait and see
What’s important when you are face with a paper loss, is to understand the reason for the drop in price of the stock.
Do not ignore the paper loss, but understand the situation and perform the best course of action for your investment.
Many successful investor when faced with a paper loss, will try to identify the reason for the drop in prices.
Instead of selling the stocks, if you believe the company’s long-term prospects is good with good financials, it might be an opportune to add more into your portfolio at a cheap price.
But if the paper loss is believed to be due to the moat of the company being destroyed and the company’s financials are in bad shape with lots of debt. It might be wise to cut your losses. This way, you can better allocate your money for other investment.
2. Loss Opportunities
Loss opportunity may not sound to be a very painful loss emotionally, but it is actually very painful for your wallet.
You might have brought $20,000 in that hot stock recommended by that cute barista down the street. After 5 years of buying that stock, the price remains around the price you have paid. Furthermore, no dividend is paid for that 5 years you hold the stock.
You might even tell yourself, “at least, I don’t loss anything holding to this stock.”
It might be true that on paper, you don’t received any form of losses.
But in reality, you have tied up $20,000 of your money for 5 years and received nothing.
If you have placed your money at some risk-free investment such as the U.S. treasury bonds, you may have earn at least 1% to 2% per annual.
Although, this level of return don’t even beat the rate of inflation of an average of 3% to 4%, it is still better than nothing.
What you loss, is the opportunity loss to better allocate your money to somewhere which gives a better return.
PS. Don’t take investment tip from a barista down the street.
When buying any stocks, it is always a good practice to ensure you will be getting a higher rate of return than the risk-free investment such as the U.S. Treasury Bond.
At least 3% above the risk-free alternative will be a good guide when buying any form of stocks.
With the increase of risk of each stock, you may want to have a higher rate of return.
Although, risk and the rate of return do not correlates exactly (It is totally possible to find low risk investment with high rate of return), but when you buy a stock that don’t even matches the risk-free return of the U.S. Treasury Bond, you are basically losing money and exposing yourself to unnecessary risk.
3. Capital Loss
Capital loss is the loss when the price of the stock have decreased in price from the initial price you have brought. This loss is not realized until the stock is sold. When the stock is sold, it is call “Realized Capital Loss”.
Perhaps the most painful and simple form of loss that many investor have experienced.
But sometimes, selling a losing position is the right thing to do. It is better to end the misery early then to suffer the pain of the loss indefinitely.
Capital loss can be painful, but sometimes selling the stock at the loss allows you to prevent yourself from suffering from an opportunity loss.
Although, you may have loss some money, due to a bad investment decision.
You will have an extra cash on hand to invest in an good investment if the opportunity arises.
4. Profit Loss
Profit loss is the loss of a significant stock run-up after you have sold the stock.
Yes, you might have felt that you have “lost the money”, because you didn’t sell at the top of the market.
You may even blame yourself for selling your stock now, taking just a 50% profit, when you can sell your stock a few days later, where you can get a 80% profit.
But the fact is, no one in the world, not even Warren Buffett can time the market correctly.
It is impossible to ensure that you can successfully sell your stocks at the top of the market, and buy at the bottom of the market.
Many investors hope that the stock will recover to regain the last high, but it almost always doesn’t happen. Even when the stock, does regain their last high, or have exceeded expectation, some investor hold on to their stock till the stock plummet in price, leading to a painful loss in investment.
Know and understand that no one can time the market to ensure that they can sell when the stock is at the highest, and buy when the stock is at its lowest.
Be happy when you are able to invest and gain a nice profit from the investment, don’t try to squeeze every dollar out of the stock.
Stock price almost always reflect the value of the stock, when the stock is over-valued and you are getting a good profit from the investment. It might be a good time for you to sell your stock and realize your profit.
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
Wisdom of Warren Buffett
Loss in the stock market can be painful experience, but every great investors learn from their experience and grow.
Dealing with losses can be tough, and some might even fear to invest ever again.
Dot Com Bubble in year 2000, housing bubble in year 2008 and later World recession in year 2020 cause by Coronavirus (Covid-19) have strike fear to many investors.
But do all babies learn to walk in just one try? Or do babies learn to walk after many falls over a period of time. After each fall, the baby learn to balance their body with their hands and legs. Eventually, the babies start to walk and even run. Investing is just the same.
Most important is not to live in the past, but to look forwards and see what can you learn from the losses.
Here are the 4 types of losses in the stock market:
- Paper Loss
- Opportunity Loss
- Capital Loss
- Profit Loss
I too have learn from my mistakes when I just started investing years ago. Journeying the world of investing as KopiBuddy, I wish to share what I learn with my readers.
If fact, if you want to learn how to prepare for the market crash and profit from it, you can read this article on “How to profit from Market Crash“.
Investing is a life long journey of constant learning.
Warren Buffett read approx 500 pages a day.
Knowledge on investment can be learn from books or articles like this one. Reading can only make you wiser and smarter, so that you too maybe able to make the right decision in your investment.
Will Durant Said:
“Education is a progressive discovery of our own ignorance.”
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Ultimate Stock Market Crash
Part 1: Signs of Market Crash
Part 2: How to Prepare for Market Crash
Part 4: How to Profit from Market Crash
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