How to React to Investment Losses

Whether it is a stock market crash or a recession scare, many investors are not sure how to react when turbulent markets push their portfolios into the red. This moneyland.ch guide answers the most important questions.

Is the money I invested gone?

Not necessarily. When the value of the assets you have invested in drops, this only results in a lower book value. What that means is, you would only lose money if you were to sell an asset at its current low price. Only when you close an investment position at a price lower than what you spent on it do you make an actual capital loss.

If you use certain kinds of derivatives – such as contracts for difference (CFDs) – a loss in the value of assets can result in a forced capital loss. This is also the case when you trade on margin, because a loss in the value of assets results in your margin shrinking. If your margin is no longer big enough to collateralize your positions, you will receive a margin call prompting you to either transfer more money to your brokerage account or have your investments sold (resulting in capital loss).

Should I stop investing?

The depends on your specific situation. During periods of economic difficulty (during a recession, for example), keeping a larger emergency cash reserve is generally beneficial. Doing so helps you protect yourself, to some degree, from the possibility of having to deal with unexpected expenses or loss of income. When finances are tight, it can make sense to put off making additional investments – especially if you expect prices to continue falling.

But on the other hand, bear markets can also be a good time to make new investments, or to add to your existing investments. When you invest during a downwards trend, you may initially make a book loss if prices continue to decline. But because you are buying assets at relatively low prices, you stand to make higher gains when markets recover. Over the long term, investments made during crises have paid off, as the historical return calculator from moneyland.ch shows.

If, for example, you had invested in the Swiss Market Index (SMI) at the beginning of 2009 – a time following months of steady decline in the Swiss stock market – your assets would have doubled in value (100-percent return) over the next five years (until the end of 2014). That is true even though SMI stocks as a whole started the year in crisis, massively dropped in value, and only reached the bottom of their down cycle in March of 2009.

But investing too early on in a bear market can also turn out to be a mistake. If you had invested earlier on in the above-mentioned financial crisis – namely, at the start of 2008 – you would only have made a 32-percent return on your investment by the end of 2014. That is a fraction of the return you would have achieved if you had invested one year later. Of course, your returns will generally be higher when you invest shortly before the market begins to recover. But there is no way to predict exactly when a recovery will begin in advance.  

Should I liquidate my investments?

Losses in the value of your investment portfolio only become actual financial losses when you sell your assets. Until you sell your assets, there is always a chance that their value will go up again. So selling when the prices of assets are low is generally not beneficial.

Of course, there may be situations in which you have no other choice than to sell during a recession – such as when you need ready money. But if you do not desperately need money and do not have good reasons to doubt your investment strategy, then selling out your investments at a loss does not make sense.

Should I make changes to my portfolio?

It is generally beneficial to stick to long-term investment strategies. Short-term losses in book value are not necessarily a sign that your strategy is faulty. As an investor, you always have to be prepared to accept setbacks in the performance of long-term investments. If you sell your securities after their prices fall, you will convert the book loss into a real loss of capital. That is true even if you invest the money from the sale in other investments. As long as there is no reason to believe that the assets in question will not eventually regain their value, selling them may well be a bad idea.

If you use an active-investment strategy and you determine that one of the securities in your portfolio no longer fits into that strategy, then selling that asset can make sense. You can then invest the money in a security which better matches your goals.

Be aware, though, that buying and selling securities generates additional costs which you do not incur when you simply sit and wait until prices recover. If making changes to your portfolio was not part of your chosen investment strategy from the start, then it is better to ignore the red figures and stick to the course.

The trading comparison on moneyland.ch makes it easy to find and compare the costs of investing with different stock brokers. In some cases, transferring your portfolio to a cheaper online broker can pay off. Be aware that your migrating to a different broker may generate costs. But a number of Swiss stock brokers will cover all or part of the transfer charges when you move to them as a new customer.

Which stocks pay off during a crisis?

If you believe that the market will not recover over the mid-term, then investing in defensive assets may be worth considering. Examples include the stocks of companies which, compared to the market as a whole, are less impacted by changes in the economy. The prices of these stocks often remain stable during downward stock market trends, or at least are less affected than other stocks.

You should be aware, though, that the value of defensive stocks may not increase as strongly as the rest of the market when the economy improves. So in some cases – particularly if you expect the stock market to improve or if you have a very long investment horizon – adopting a defensive strategy during a bear market might not bring any advantages at all.

Can I compensate for losses using speculative investments?

Pinning all your hopes on one winning card may seem the realm of luckless gamblers, but some small investors do exactly that when the stock market takes a turn for the worse. When stock market developments drive your wealth down and you lose sight of your long-term investment goals, you may be tempted to compensate for your book losses by making speculative investments.

But the more speculative an investment is, the higher the risk of losing money is. Increasing your risk of loss at a time when your portfolio already is not performing may not be the wisest thing to do. Your risk capacity declines in direct correlation to your wealth. That makes using diversified, affordable investment products like exchange-traded funds (ETFs) to reduce risk even more important when the value of your portfolio declines.

Strategies like day trading and using high-risk investment vehicles require a great deal of know-how and an above-average capacity for loss. As such, they are best left to professional investors.

More on this topic:
What to do when the stock market crashes
How to react to recessions
The most important investment strategies explained
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