Rethinking Loss in the Stock Market
Losing money on a stock hurts. Everyone wants to avoid bad investments, but maybe we think about paper losses the wrong way.
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Stocks go up and stocks go down. It's fun to watch your investments increase in value, but it feels awful when they decrease.
Don't fret! If you have good investments, you can weather the daily ups and downs of the market without getting caught up in the frentic daily horse race stock reporting.
If the Dow, S&P 500, or NASDAQ index drops a percent or two and you feel uneasy, you're in good company. On paper, you may have lost hundreds or thousands of dollars. Yet take courage: daily, monthly, and yearly fluctuations are mere bumps on a long road. If you take a longer view—if you think of losses differently—you will invest with more confidence.
When Do You Lose Money on a Stock?
It stings to look online and see that hot stock you had such confidence in lost a couple of dollars per share, but remember this: you only make a profit or suffer a loss when you sell.
You have not lost anything until then. The value of a stock is as much its future worth—the share in its earnings in the present and future—as its current price. Let this principle guide your decisions. Regardless of the current price of a stock, you still own a part of that business and share its value. Unless and until the nature of the business changes, you've retained that value... and you may have found more opportunity.
What Happens When the Stock Market Goes Down?
When stocks go down, people rush to ask "What happened in the market today?" This is a normal question. Usually there's no single explanation which accounts for all of the actions of all of actors in the market. Even as simple an explanation as "There's a rumor the Fed will raise interest rates" can't account for every sell and every buy.
Even if you could explain what happened after the fact, what could you do with that information? Perhaps a rise in interest rates changes the business strategy behind the stocks you own—but if it makes those businesses no longer worth owning, were they ever worth owning in the first place? (This may be a blessing in disguise for great companies, by encouraging poor companies to leave the market altogether.)
Even if you've fully invested in index funds, you might be better off not doing anything. For example, when the Dow drops a hundred points, that could mean that only one stock, say IBM lost a few dollars. Everything else could have gone up. (The Dow's price-weighted model has problems like this.)
It's more important to see trends beyond the daily or weekly or quarterly fluctuations.
If you've invested in good businesses which will continue to be good, each share is an investment in a bright future. Daily ups and downs are just steps in a longer journey. To try to draw conclusions based on these fluctuations is to attempt to divine meaning from a thousand random points.
If you're a value investor looking for bargains, dips and drops in stock prices are expected—even, occasionally, valuable. Warren Buffett's on record as advising that there are bargains to be found when other people are fearful; be bold when the rest of the market runs scared and be cautious when the rest of the market is confident.
The point of value investing is to find overlooked opportunities. That means bargains. Find stocks worth more than their current prices and plan for great returns over time. No one can control the market's fluctuations, but you can do your research and find strong companies with good histories.
How to Make Money in a Down Market
Sometimes a stock's price drop is an opportunity. If the stock were a bargain at $10 per share, how much more so at $8! You may legitimately decline the opportunity to buy more for good reasons such as the desire to diversify or to adhere to an investment budget, but the opportunity remains.
This can happen for you without direct involvement, if you practice dollar-cost averaging or dividend reinvesting. Whether this is deliberate purchasing on a timescale, or an automatic investment through a 401(k) or SEP, a minor adjustment in a stock price gets you more for your money and multiplies your eventual gains. Through the gradual magic of compound interest, an extra percent return here and there can add up to thousands of dollars.
If the company is still strong, the intrinsic value of the stock remains as it is. Seek strong companies with great businesses you understand. Sleep soundly even despite the daily random machinations of numbers. Seek value.