If you decide to invest in the stock market, you must prepare yourself for temporary investment losses. I use the word ‘temporary’ because this is how I have always viewed losses to my account and I’ve been investing in ISAs since 1997.
Temporary investment losses in your account are normal, natural and, unfortunately, unavoidable. Your temporary losses can increase in size if, like me, your goal is to achieve outstanding investment returns over the long-term.
Personally, I think it’s a great idea to set the goal of beating the market. However, aiming for high annual returns means the possibility of huge swings in your account in the short-term. Therefore setting a goal to beat, let’s say a powerful index such as the Nasdaq Composite adds risk and volatility in the short-term.
Unfortunately it’s a fact that if you don’t want risk or volatility in the short-term, you should not be investing in the stock market. Wouldn’t it be great if you could invest in a vehicle that had huge upside potential and very little downside risk? Yes it would, but unfortunately they don’t exist.
Even bull market corrections can be scary
Let me remind you that the market does not go up in a straight line and must correct in price from time to time. During sustained upwards trending markets that tend to last two to four years, I like to stay fully invested. However, during that prolonged uptrend, there are always going to be what’s known as bull market correction periods.
Sometimes bull market corrections can be quite scary and they hurt. If you make the mistake of keep checking your account value each day, the short term sharp drops could make you feel physically sick. Corrections over the latest bull market that started in March 2009 have been varied in length and size and the largest one was 22.9% in depth and almost a year in length.
Stay fully invested during bull markets
With the pain that comes with bull market corrections, some people ask why I don’t get out onto the sidelines when a correction begins. The answer is because that’s impossible to do on a consistent basis. Since my investing career began, my experience has taught me that riding out the bull market corrections is a much sounder strategy and reaps larger rewards. This means staying fully invested. Temporary investment losses are therefore part and parcel of the game. My belief is that you can only win in the long-term if you accept volatility, risk and temporary losses in the shorter term.
If your temporary investment losses ever cause you to lose sleep, it means you are probably investing too much money and need to scale down. A good idea might be to switch some of your capital out of the market.
Also remember that with your investing it does not need to be an all or nothing decision. Instead of investing all of your capital, you can invest say, 50% and leave the other 50% in cash. This helps lower the volatility.
Temporary investment losses of £300,000
Let’s now look at how you would feel if you were to take a big percentage drop on your portfolio. This of course would be what we call a temporary or paper loss. If you are playing the long-term game, the loss should be viewed as a temporary inconvenience. However, you may be inconvenienced for some time, especially if a major downtrend (bear market) is triggered. Let’s look at how this works.
Imagine that you invested £100 into the stock market. You invest and the market and your fund heads south over the next twelve months. The net result is your £100 dropping to £70 - a 30% drop. How would you feel about that 30% loss?
Sitting on a paper loss of £30 may not seem too much of an inconvenience, but what if the amount invested was more? For example, what if your portfolio was valued £250,000? In this case, sitting on temporary investment losses of £75,000 would cause some people tremendous stress and anxiety. On the other hand, people with the right mindset would be more comfortable with their paper loss. Imagine taking a temporary 30% loss on one million pounds.
Setting the right expectations helps calm your nerves
What’s important to understand is that throughout your investing career, you are going to have ugly short-term periods in the market and you need to start preparing your mind now for how you are going to cope when it happens.
Winning investors cope with paper investment losses by having long-term goals and constantly thinking long-term. They expect ups and downs throughout their investing term because when an adventurous investor aims for double digit gains over the long-term, they are forced to learn how to deal with temporary losses. One way to do this is by seeing them as a temporary inconvenience.
Many investors in their late 50s and 60s – approaching or already in retirement – have been coached by media and industry professionals to think about their investing time horizons in a way that, in my view, is all wrong.
Most people naturally think their investing time horizon ends when they either retire, stop contributing to their retirement funds or start taking cash regularly from their ISA or SIPP portfolio. They mistakenly think that’s when they should reduce most, if not all, volatility risk and start thinking ultra conservative. My view is you should see investing as something for life and base your investment time frame on the amount of time you believe you have left to live.
Longer lives, longer time horizons
People live longer than ever now, yet many invest, by and large, like they expect to die at age 70. Thanks to better education, nutrition and mind blowing technological and medical innovations, people are living longer today than thought leaders were thinking fifty years ago.
According to the Office of National Statistics, the number of further years someone reaching 65 in 2008–10 could expect to live is higher for women than for men. Based on 2008–10 mortality rates, a man aged 65 could expect to live another 17.8 years, and a woman aged 65 another 20.4 years
This means that the average 65 year old male will live until they are 83, but some 65 year old men will beat this average and live longer. And my guess is, much longer. Think about it, in these next 20 years, there are going to be more medical advancements that we can fully fathom now. And today’s retiree is overall more fit, active and healthy than ever before.
What this means is if you’re 65 years old or approaching 65, my suggestion is to change your outlook and adopt a long-time investment horizon and start to see investment losses as temporary.
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