One Simple Way to Protect Yourself from the Fear of Taking a Loss
Gold bullion has lost almost 15% since the beginning of 2013. While gold’s ceiling may be limitless, its descent isn’t. Like any investment, it can, theoretically, only go to zero. Sadly, some investors are so afraid of losing money that they’ll hold onto a plummeting equity at any cost.
If you followed the herd and purchased gold at its peak in early September 2011, you would have had to fork out roughly $1,923 per ounce. Fast-forward a couple of years, and on April 16, gold opened at $1,355. Those investors who bought gold at its peak have since seen their holdings plunge 30% in value.
Those holding onto bullion in hopes that it will rebound may have a while to wait. Gold is currently trading at lows not seen since early 2011; for investors looking to recoup that 30% loss, gold prices will have to climb 42%. That’s a pretty sharp increase.
Facebook, Inc. (NASDAQ/FB) is still trying to recover from its botched initial public offering (IPO), and a lot of investors have been holding on for the ride. In May of 2012, the company opened trading near $40.00 per share; in September, it was hovering near $18.00, for a four-month loss of 55%.
For investors to simply break even, they need to wait until Facebook’s share price climbs 122%. While Facebook’s share price has rebounded to $26.00 per share, it still needs to climb an additional 53% to match its IPO price.
By turning your back on a losing stock and selling your position, you can free up cash and invest it elsewhere. But the fear of taking a loss can be powerful. The fear of losing is one of the most dangerous emotions an investor can have; in fact, the fear of losing money is far more intense than the pleasure we get in making a profit of the same size.
Whether we’re conscious of it or not, selling a bad stock makes the loss feel more real—up to that point, it’s just a paper loss. Conversely, we sometimes sell winning stocks too early, fearing we’ll lose out on already realized profits.
The point is that it can take a long time for stocks to recover (if they even do). During that time, your money is tied up in investments that may or may never appreciate. Investors could save themselves a lot of emotional stress and grief by having an investment strategy, such as setting up a stop-loss (preset loss level), selling the losers, and looking for other opportunities.
A good case in point was the 2008 financial crisis. After the markets crashed, investors looked for safe equities and poured money into bonds. In late 2008, the Federal Reserve stepped in with the first round of quantitative easing in an attempt to instill a sense of confidence in the markets and bring liquidity to the financial system.
The markets responded to the news favorably. However, most investors, afraid to lose money in an uncertain rebound, stayed in the bond market. Five years later, they’re jumping into the stock market, afraid of not making money.
Sadly, we’re only human, and it’s difficult to not follow our hearts when it comes to investing. Fortunately, to help combat our fallible human nature, there are investment tools we can take advantage of.
A stop-loss order is the best way to limit a loss. Depending on your aversion to losing money, you can set a stop-loss for any amount you like. If you had purchased Facebook at $40.00 and were willing to take a 10% loss, you would put in a stop-loss order at $36.00; or $38.00 if you can only stomach a five-percent loss. Taking a $2.00 or $4.00 loss per share might sting, but not nearly as much as having your money tied up on a loss of $20.00 or more.
For those who do not trust their emotional judgment when it comes to the stock market, stop-losses are a great way of helping you make up your mind. It may sound obvious, but judging by the number of people still holding onto stocks after experiencing a sustained slide, it’s not.